The child’s thrill of being free to ride, almost feeling as if you could fly! The parent’s trepidation of letting the bike go for the first time. Sometimes that first ride goes without a hitch. It often ends up with some scrapes and bruises, but ultimately ends in success.
I think we are at that moment where the parent is running alongside the bike, just about ready to let go for the first time.
I am currently modestly bearish the overall market, though bullish on re-opening type trades, and bearish on some of the biggest winners. On credit, I’m cautious and resisting the urge to hit the “buy buy buy” button, but think that time will be soon. I’d really like to load up on European and emerging market risk, but I’ve locked that “buy” button away for now. This follows up Sunday’s ΔΓΟ (Delta, Gamma, Omicron) report. It also fits nicely with yesterday’s Bloomberg TV where we hit on many of these subjects.
What Training Wheels are Being Removed?
I think there are a few key elements that the markets must digest. Some have already started to get priced in, some have been discussed, but not reacted to, and some I think are being ignored at our own peril.
Less Supportive Central Bank Policy. This is starting to sink in. Powell finally got rid of the word transitory. Markets are trying to figure out if a policy mistake is coming (curve flattening). There is also some discussion about just how serious Powell is. The Bank of England after all, had the market all set for a hike and then flaked at the last second. So, it is reasonable to believe that Powell may be talking tough, but won’t act tough. I expect a much faster pace of tapering to be announced at December, while he tries to downplay the need to hike, or how far and fast they will have to hike. In any case, I think the market must absorb a bit more volatility, especially in the stocks that seem to have been most dependent on TINA (there is no alternative).
Inflation has become a political hot potato. If you think Powell’s job was already difficult (which it is) add in the fact that politicians are now weighing in on inflation. Some of their takes strike me as completely absurd, but inflation and interest rates have moved out of the wonky world of Wall Street into the soundbite world of D.C. I think this is such an important distinction that I have treated it as a separate bullet point, rather than lumping it into the less supportive central bank bullet.
Consumption was brought forward. The T-Report has been speculating about the idea that consumers, not being stupid, responded to supply shortages, by loading up on goods early, for well over a month, but now we are seeing signs that the speculation may be accurate. Black Friday sales were down (even with higher prices). Ditto for Cyber Monday (btw, the number of “you still have time to get XX% off” e-mails that are flooding my inbox, isn’t comforting). Finally, yesterday, Apple told suppliers iPhone demand is slowing ahead of the holidays. I don’t think any risk of consumer slowdown is being priced in, largely because it is a highly speculative argument I’ve made, but as anecdotal evidence starts getting supported by hard evidence, this could become a market moving issue relatively quickly. Maybe we see a shift from spending on goods to services, but that assumes that consumers aren’t tapped out, and that covid won’t interfere with the service oriented sector (a risk that seems to be increasing with the omicron variant).
The Re-Centralization of China. The August 1st T-Report discusses the basic premise that China is delinking from the global economy, and reasserting the authority of the Communist Party. Nothing has changed since then, and China continues to plow ahead in the process. The biggest takeaways are that China will no longer act as a deflationary influence and that businesses and the global economy need to adjust to this new reality. KWEB, a China Internet ETF is down 42% YTD, but its 3 year annual return is just over 1% (that seems shockingly low). FXI, a broad based China ETF is “only” down 18% on the year but has annualized losses of 1% of the past 3 years. Normally, as a contrarian, I’d be chomping at the bit to buy these, but I won’t touch them as I think it is reflective of an ongoing trend that will not reverse quickly. It might also be worth mention that Lehman was NOT a Moment, and the Evergrande/real estate story in China is far from being resolved.
I think we can remain cautious on risk, continuing to shift into companies and industries that will benefit from a focus on domestic supply chains (production repatriation) while being cautious on those stocks that most benefitted from the environment that seems to be ending to me.
The bright side, is I do see an economy and market that will be really exciting to be a part of, and that we might even skip the scrapes and bruises, though I suspect we won’t learn to ride without training wheels without a little more difficulty.
While I did mention covid once in this report, I want to re-emphasize that my concerns right now are NOT tied to covid at all (I suspect we will adjust to the new variant and governments across the globe will not muck things up with unnecessary and/or impractical rules).
In any case, December might be more interesting than usual!