During the first internet boom, the business model of South Park's Underpants Gnomes was commonplace, as scores of companies flooded the marketplace, sustained purely by the promise of future profits that would somehow magically appear. As Grant Williams scoffs in his most recent letter, it was the corporate embodiment of George Costanza’s “yada, yada, yada”: “First we build a company... yada, yada, yada... we make billions.” Of course, most of these companies went the way of the dodo; but remarkably, a mere 14 years after the bursting of the original internet bubble, there are signs of what Yogi Berra so beautifully referred to as “déjà vu all over again” - signs which some real heavyweight financial minds have recently highlighted...
These two charts depict the same index over the same time frame, but they reflect two stories and two economies.
Does this look in any way normal to anyone?
Simply put, there are three downside risks for markets - that appear to be off the 'meme of the day' beaten track of any average investor nowadays eyeing the record highs and gloating at any bear left standing:
1) China has shifted from a monetary policy of choice to a monetary policy of necessity.
2) The Narrative of Fed Omnipotence continues to reign supreme, but now in a tightening monetary policy environment.
3) The Hollow Market is cracked open by well-intentioned but destructive regulators.
Too long to read? Attention Deficit Disorder let you down...? Read!
What is an underlying explanation that can account for Momentum failing and Value working, but Quality NOT working? When one of my colleagues here at Salient saw these charts he said, “looks to me like the market is trading on a narrative of risk appetites and fear rather than toward some notion of seeking fundamentals or selling overbought growth stocks; otherwise Quality would be working, too.” To which I replied, “Amen, brother!” The notion that this market sell-off is limited to biotech or Internet or some other high-flying sub-sector because the market “realized” that these stocks were too expensive or out of concern with earnings this quarter (both explanations that I’ve seen of late in the WSJ and FT), just doesn’t hold water. These high-beta stocks are being hit hardest because they are at the epicenter of a broad market or beta earthquake. This is what it means to be high-beta…you live by the broad market sword and you die by the broad market sword.
What we’re witnessing right now in US markets is a shift in the Narrative structure around Fed policy, and it’s hitting markets hard because the Narrative structure around the Fed as an institution has never been stronger or more constant... "So now we will all start to act as if the statements are true for Fed policy, no matter what we privately think the Fed will do or not do, and that behavior becomes a self-fulfilling prophecy, a snowball rolling downhill, as more and more of all of us start to believe that this is what all of us believe. This is the power of a crowd looking at a crowd, and it’s a bitch."
The mainstream recovery narrative has an astounding “recency bias”. According to all the CNBC talking heads, the 192,000 NFP jobs gain reported on Friday constituted another “strong” report card. Well, let’s see. Approximately 75 months ago (December 2007) at the cyclical peak before the so-called Great Recession, the BLS reported 138.4 million NFP jobs. When the hosanna chorus broke into song last Friday, the reported figure was 137.9 million NFP jobs. By the lights of old-fashioned subtraction, therefore, we are still 500k jobs short—notwithstanding $3.5 trillion of money printing in the interim. The truth is, all the ballyhooed “new jobs” celebrated on bubblevision month-after-month have actually been “born again” jobs. That is, jobs which were created during the Fed’s 2002-2007 bubble inflation; lost in the aftermath of the September 2008 meltdown; and then “recovered” during the renewed bubble inflation now underway.
The jobs number expectation had been falling for a few days into the print this morning and despite the desperate efforts of every status-quo-hugging TV talking-head's Goldilocks scenario, it was not a good report - it missed low expectations and it seems the market is realizing (having been told the bar is very high for an un-taper) that the Fed will not rescue it any time soon. GDP expectations are also tumbling and thus the hope-driven hyper-growth stocks have been monkey-hammered. This is the worst swing for the Nasdaq since Dec 2011 (with Russell, Dow, and Nasdaq -1% YTD). Momos and Biotechs were blamed but this was broad-based selling as JPY carry was unwound in a hurry. Gold rallied above $1300 (+8.1% YTD) as bond yield ripped lower for 5Y's biggest daily drop in 10 weeks (short-end -4bps on the week). VIX pushed back above 14 (but it was clear derisking exposure - as opposed to hedging positions - was the order of the day).
I think we are now even more strongly in a good-news-is-bad-news (and vice-versa) world. If we start seeing some strong economic data come out over the next few weeks and months, then I think the market - particularly the bond market and emerging markets - could get pretty squirrelly. Not that US stocks would be immune from this. Remember, the modern day Goldilocks environment for stocks has nothing to do with a happy medium between growth and inflation, but everything to do with growth being weak enough to keep an accommodative Fed in play. Strong growth data would augment a Common Knowledge structure that the Fed is on track to raise rates sooner and more rather than later and less, and that's no fun for anyone. Then again, if global growth data remains weak - and you really can't look at what's coming out of China, Europe, or Japan and think that the global growth story is anything but weak - that creates enough uncertainty about the Fed's path (not to mention the cover for political and economic Powers That Be to wage a full-scale media war to keep monetary policy in QE la-la land forever) to support the markets. Sounds a lot like Freedonia to me. Rufus T. Firefly for President?
Ordinarily Grant Williams would bet the ranch on this spat being defused diplomatically and everybody leaving the negotiating table a little disgruntled (which would mean the outcome was just about perfect); but he suspects that markets have become dangerously conditioned — by one perfectly executed landing after another in recent years — to expect (and position for) the best. The trouble is we've been here before and pulled back from the brink every time, but this time that outcome is expected again by most, and that is extremely dangerous; as markets are most assuredly NOT ready for reality. Add to that the fact that every new Fed chief gets a serious test - perhaps it is Yellen's turn?
This past week has seen the market struggle due to continued weak economic data, rising tensions between Russia and the Ukraine and an extended bull market run. Market internals are showing some early signs of deterioration even though the longer term bullish trajectory remains intact. Therefore, this week's "Things To Ponder" wades through some broader macro investment thoughts, from the safety of your investments to how market tops are made.
The soon-to-be-renamed-Boring-Book, for its constant uniformity of mediocre Goldilocks data offered little to strengthen bulls or bears (as usual) but it seems weather was the key once again. With 119 references to "weather" (6 times more than the January report), they remind us that:
- *FED SAW ECONOMY GROW EVEN AS HARSH WEATHER SLOWED HIRING, SALES
- *FED SAYS OUTLOOK 'AMONG MOST DISTRICTS REMAINED OPTIMISTIC'
But - the "m" words continue to dominate:
- *FED SAYS MOST REPORTS OF IMPROVEMENT WERE 'MODEST TO MODERATE'
As 8 of the 12 districts "reported improved levels of activity"... but but but the weather. Healthcare concerns were cited 16 times.
Sometimes you just have to sit back, look at some charts, and say WTF...
A considerable area of investor concern remains on emerging economies. As UBS' Larry Hatheway notes, the last thing that vulnerable emerging economies need at the moment is worries about a global growth slowdown, if that is indeed what is happening. That’s particularly true given that one of the relative few bright spots in the emerging complex of late was improved PMIs, reflecting some pickup in global manufacturing, exports and trade. While that lift might not help the down-trodden commodity producers within the emerging complex, it is helpful for the more manufacturing-oriented economies of Asia, selected parts of EMEA, or Latin America. But as Hatheway warns below, emerging vulnerability is about much more than just growth.
... our default is a Goldilocks scenario between now and the next FOMC meeting in mid-March. It means that bad macro news is good market news, and vice versa. If the next ISM manufacturing number (no one cares about ISM services) is a big jump upwards, the market goes down. Ditto for the February jobs number. If they’re weak, though, that’s more pressure on the Fed and another leg up for markets. Place your bets, ladies and gentlemen, the croupier is about to spin the roulette wheel. Pardon me if I sit this one out, though. My crystal ball is broken. If I’m right, what does this mean for the real world? It means an Entropic Ending to the story … disappointing, slow and uneven growth as far as the eye can see, but never negative growth, never an honest assignment of losses to clear the field or cull the herd. That’s not my vision of a good investment world, but who cares? I’ve got to live in the world as it is, even if it’s a long gray slog.