I was having a chat the other day after a round of golf, and a person asked me what I studied in college. I must say, nothing perturbs me more than answering that question. Not because I don’t appreciate people showing a genuine interest in getting to know me better, but because the reasons I studied economics were ridiculous, and because it wasn’t where my interests were. And, after getting a C+ on my first exam in Econ 101, I should have trusted my instincts. I should have majored in history. But, it meant way too much reading, writing, and typing (remember, this is pre-word processors). Economics was always two exams – midterm and final – and that was it.
Now, one good thing economics does try to teach you is to think critically about how economics/markets should work vs how they actually work and try to reconcile why. After a while, you realize there is not that much scientific/definitive about it, and it is just a language to help piece never-ending puzzles together. If it was up to me, the economics curriculum should have many more classes on economic history, the evolution of economic thought, but that would probably reveal how imprecise and politicized the “science” is.
There are some strands, led by Dick Thaler at Chicago, called behavioral economics which attempts to bridge the gap of theory vs reality. He wrote a great book about the subject matter entitled “Misbehaving” and he was recently awarded a Nobel Prize. His discipline is focused on how economic agents make choices, sometimes illogical/irrational and against their own interests, which can make it difficult to optimize policy. Much of the discipline leans on work from Israeli academics Daniel Kahneman and Amos Tversky, and it is all pretty insightful, and maybe partially explains why AMC is investing in a gold/silver mine, unrelated to their existing business – because this CEO believes he has a line into village idiot asset allocators (ie. Apes). But, behavioral economics does not give us anything definitive, just a new realm of social science that attempts to explain why outcomes deviate from theory. In markets driven capitalist systems, these can be both issues and opportunities. In totalitarian ones, less so…
At this particular moment in time, we are at a fork in the road where the market is inching toward appreciating the gravity of the situation but not really fully priced for it, as I illustrate below. In that way, there appears to be a behavioral bias that is very tough to shake. Maybe because we are inundated with (mis)information/distraction, because markets were artificially disconnected from economic facts on the ground around the pandemic, and because buy the dip has been the money-making mantra for a while, we are losing some sensitivity to the enormity of the shifts.
As I have written in the past few notes, the breadth of possible futures has the potential to be highly destabilizing for markets for quite some time. While I don’t foresee the US$ losing its dominance anytime soon, I do see a world of competing blocs for power and security (physical and economic), strained/redundant supply chains, inflationary pressures, and more constrained capital mobility/opportunity.
During the GFC, the world learned quite a bit about financial system plumbing and risks. During Covid, we learned that viruses can be deadly and that globalization can have negative effects. During the last year, we have learned that deficit spending and money printing without concurrent increases in productivity and supply, causes inflation. In the Ukraine crisis, we are learning that world order can be thrown into disarray and that economic security relies on critical inputs. Of course, we should already know this stuff, and do all we can to protect against harm, but we don’t.
I am still managing my risk reasonably tight with a lot of cash, and have been tapering my shorts in ARKK, IWF, and IWM as concerned a bit about the end of quarter rebalancing in short gamma land. I have some Tesla downside butterflies centered around 800 that come off in a few days, and outright short a bit, as I do expect costs, supply disruptions (Tesla sources some from Russia), and China’s covid issues to impact the name, and will add shorts on strength. Thought this article on price increases on consecutive days from Tesla was interesting as well.
Things that caught my attention this week:
Asset Allocation:
I ran across this table from Merrill Lynch Private Client Group CIO and I think it is a good depiction of how to think about asset allocation in this period. The “Great New Dawn Era” strike does not appear to be as favorable for risky assets.
Flows:
Really more of the same with Europe outflows leading the charge. Interesting to see decent flows in China, given their markets – technology in particular – have gotten hammered.
Just to put this on the radar, we are likely to have a large quarterly rebalancing out of bonds and into stocks.
The almost quarter of a trillion-dollar estimate from JPM is huge. It is about now that this should start being put to work. JPM: “The pending rebalancing flow for the end of March, which we estimate at up to $230bn out of bonds and into equities from multi-asset investors such as balanced mutual funds, US defined benefit pension funds, the Norwegian oil fund, the SNB, and the GPIF. This above-average rebalancing flow should support equity markets into the end of this month” (JPM)
Sentiment and Positioning:
In the past few years, it paid to “buy the dip.” Maybe it still does. There is any number of bear market-type rallies that can take hold, but the broader situation that I have been harping on for a while is that participants are invested. They had to be. There was literally no way to generate needed returns in a low-rate environment without either levering up, going out the risk curve, taking on illiquid assets, or chasing yields/returns. If I take anything from the chart below, it is that while the sentiment is further shifting into a risk-off zone, the equity market flows are not anywhere near the capitulation stage.
And, these two charts come from BofA Fund Manager survey, which indicates a disconnect between what survey participants think, versus actual exposures as well as the crowding in the long oil and commodity trade.
And for some historical perspective on the survey over other crisis periods, here is the following table. Notice that equities are still overweight relative to past downturn/c periods.
Fed/Central Banks:
The ECB pretty much played to expectations, and I expect the Fed to do the same, raising 25 bps. Supply-side disruptions such as the oil embargo (put in place because of the US support of Israel during war) are truly difficult for central banks to manage, and most CBs try to see through it. But, as I wrote last week, I do expect the Fed to try to normalize while they can. Whether they can get any more than a few hikes in vs what is priced is still TBD.
I have launched into the Fed enough because the AIT regime was dumb AF. And, I have talked about shifting Fed priorities, some reasonable (employment) and some not (climate, diversity), but all of those may be tied to a trend within the institution which has moved distinctly left, as illustrated by this WSJ article. https://www.wsj.com/articles/how-politicized-is-the-federal-reserve-democrats-republicans-climate-monetary-employment-11646687942. A good chunk of the population is (re)learning for the first time in a generation that keeping a lid on inflation matters.
Morgan Stanley has had a good call on this all, so including:
Europe issues and US companies:
It is normal to see commentators mention that Russia is a small economy with insignificant bilateral trade with the US, and failure to appreciate how integrated Europe is with Russia, and of course, how integrated the US is with Europe. Even though bilateral trade – in national accounting terms – is reasonably stable, US company earnings via their European affiliates are highly exposed to a slowdown.
How will the war impact the global economy?
Was flipping through University of Chicago Booth School articles, and saw this piece which is a survey of academics globally on how they see the war impacting the economy.
Interesting that in Statement A, few disagreements about growth down and inflation up (or not going down from high levels) as a result of the Russian invasion.
And, is interesting that the panel of experts is really mixed on the idea that there will be a significant shift away from the dollar as the dominant international currency.
I have written about this, and its good to see my comments are somewhat in sync with those who believe the lack of China’s attributes to challenge West supremacy (which is how this should all be viewed with the US$ as the largest player in that coalition) and the lack of alternatives makes this all interesting fodder for discussion, but not actionable any time soon. Yeah, it was a bold move and put the question into the public sphere. Here is another good viewpoint from WSJ’s Andy Kessler that fits into the common-sense narrative.
Anyhow, if we take a step back and ask, “if we knew in 1990 what we know now – which is that Russia and China will talk a good game about globalization, shared interests, and growing the global pie for everybody” would devolve into the current geopolitical mess, would we have moved supply chains, relied on energy from Russia, and been near as tolerant of the myriad of anti-West actions (including cyberattacks, intellectual property theft, dumping, etc.) or would we have moved at a glacial pace? Such is the result of a naive and poorly executed policy.
China has a role to play to reverse some of this all. That they are not, is speaking volumes, and maybe a significant miscalculation on their part given the resolve of not only European nations but also Asian as well.
Other Tidbits:
Inside the mind of Putin
Here is a really good New Yorker article that explains the Putin mindset in an interview with noted Russian scholar Stephen Kotkin from Princeton. He also lays waste to the idea that any of this is the fault of the West that has been put out by some and used as propaganda in Russia and China.
Is China Investible?
Investing is not just about buying a bunch of ETFs. ETFs are fine, and they serve a purpose, but, they mask a lot as well. In the case of China, the big issue has always been governance and VIE structure. More recently, that market has seen the heavy-handed nature of the government. But, as this Bloomberg piece notes, it is not like they really care all that much, as long as the real economy keeps growing (which has been slowing).
Tim Cook’s pay package, ISS proxy services, and ETF’s
For starters, in the context of Elon Musk’s pay package, we are talking about peanuts. Legendary VC investor from Sequoia Capital Michael Moritz took to the FT in an editorial over the vote to approve Tim Cook’s pay package.
But the piece is not really about Cook’s compensation. He makes the point that Cook has clearly added a ton of value to shareholders:
Rather, the point is about ISS (and its competitors) that serve as a proxy for a number of shareholders and does this across 45,000 shareholder meetings, has neither the time nor expertise to opine on the specifics at hand, and is simply pressing popular agenda items that feed its other business lines.
Where does this power come from?
This leads us back to the dangers of ETFs and passive investing and also the role that boards play to have a spine and do the right things.
Political actors can impact corporations by pressing these shareholder services (that 36% voted against Cook’s package is absurd) and create a lot of suboptimal/dangerous decision-making. I have made the argument before that corporations should do the right things by their stakeholders, including the government. No entity exists in a vacuum and yeah, success and compensation should be scrutinized. But, this was the wrong hill for ISS to push their agenda. If we are learning anything these days, it is that some of the most favored priorities of the left are trite compared to the well functioning of our institutions, and the key people/leaders that ensure it thrives. Good leadership and thoughtful stewardship amidst the turbulence, noise, and idiotic activism are hard to find. We don’t have political leaders who can hold a candle to Tim Cook who should be as well paid as he is.
Analogue of the week:
Head Scratcher of the week – the LME:
Obviously, the LME decision to cancel a few billion trades is pretty curious. I heard the head of the LME mention that they were acting in the best interests of their stakeholders, but this is all a really bad look. It goes to show that crisis/disturbances tend to reveal malpractice. Madoff did not get uncovered until the GFC.
