As the stock market and the FOMO chasers remain unhinged from reality (3 standard deviations above mean valuations) about as much as the crowd we watched in horror invade the Capitol yesterday, it’s time to revert to a fundamental story that is consistent, logical, and will probably make you some money that you will be able to keep and bank over the medium-term. No, not Bitcoin.
It’s also an interesting story full of geopolitical intrigue. We will keep it short and sweet with some pictures.
Short Straight Of Hormuz
The U.S. didn’t import any Saudi crude last week for the first time in 35 years, a reversal from just months ago when the Kingdom threatened to upend the American energy industry by unleashing a tsunami of exports into a market decimated by the pandemic. – Bloomberg, Supply Lines
Long Taiwan Straight
Taiwan will become geopolitically important in a way that the Middle East never was. Modern semiconductor manufacturing is at least as important to the economy as oil was in the 1970s. But in the case of oil, at least it was available all over the world albeit at higher prices than in the Middle East. Imagine a world where oil only came from one country, and how important that country would have been for the last hundred years. That is what the world would look like if Intel cannot find its footing and continue to manufacture chips at the leading-edge here in America. Taiwan could become by far the most geopolitically important country in the history of the world. – themarket.ch
Happy New Year, everyone! I hope everyone had a happy and relaxing holiday season – or as happy as can be in the midst of a global pandemic. I’ve been fighting a bout of pneumonia and was officially diagnosed with “The Covid” (as it’s known in my neck of the woods) last week. I am blessed in having access to a fantastic team of doctors and my family taking excellent care of me.
After the holiday hiatus, I was eagerly anticipating getting back to work in my home office this morning — markets are my passion, so it’s not really work. Things started out promising, the three major indices in the green in the pre-market. I messaged Gregor saying it appears we’re picking up where 2020 left off. I checked my Twitter feed an hour or so later to see what’s going on and BAM! …the Dow had dropped over 600 points, and the S&P 500 and Nasdaq were down by similar scary amounts. And you know what? I didn’t even go to CNBC to see why, because I’ve learned in my time managing my own portfolio that the “experts” rarely know why these drops occur.
Having experienced a few down days in my time managing my own and my family’s charitable foundation money, I’ve developed a set of guidelines which I sent out to a family member earlier today after she frantically texted asking what was going on in the stock market and how she should react. I thought I’d share my thoughts today with GMM readers as well.
CK’s Thoughts on Market Volatility
Try to have some liquid “dry powder,” funds that can be used to purchase stocks on your watchlist when a market selloff occurs.
There’s a clear pattern I’ve noticed over the years regarding market selloffs. I’ll retrace my observations here for our readers.
1. Fear sets in over some perceived threat (Dems taking the Senate, threat of a massive Covid resurgence threatening almost total shutdowns of the economy, Bitcoin collapse, Trump starting a war, runaway inflation or stagflation sets in, etc). Take your pick, it doesn’t matter which one if any, the narrative you select. Trust me on this.
2. Just about every stock in the market drops dramatically, regardless of the quality of the company, it’s fundamentals, what products or services it offers. Nothing matters, traders and many investors alike panic, and a massive selloff ensues. Fear-based selling begets more selling until the market eventually bottoms.
3. A few days will pass, the event or narrative in item #1 either happens or doesn’t happen. It doesn’t matter if it happens or doesn’t happen; trust me.
4. At some point, and probably sooner rather than later, the cream will start to rise to the top again. In 2021, the “cream” is high-quality, forward-looking companies in technology, the disruptive space, and of course, essential products and services, aka, consumer staples and healthcare.
5. Timing the absolute bottom is an exercise in futility, but once you’ve been through a few of these massive sell-offs, you begin to get a feel for when it could be an excellent time to start dipping your toes in the market waters and start buying a few shares at a time. With commission-free trading offered through most U.S. brokerages, buying in smaller lots is the smart way to buy.
6. Patience is critical here. It can be hard to hold on when you look at your portfolio and see a drop, whether it’s 2% or 20%. As the legendary Tom Petty (RIP) sang, “the waiting is the hardest part’. Investors and traders are warned not to “catch a falling knife,” but it’s also important not to wait too long on the sidelines until the rebound is clearly in play.
7. Remember this: stocks go up, and stocks go down; over the long run, the U.S. stock market has returned an average of 10% per year to those with the patience to stay invested at all times. It’s not a straight line up; indeed, it’s quite often a bumpy ride. Alas, at the end of the day, if you can’t stomach an occasional 10-20% drop, you probably shouldn’t be invested in the stock market. I hear money market funds are paying something like 0.03% APY…
8. Finally, to paraphrase Gregor: all of the above in the context that valuations are “very stretched” to begin the New Year, to say the least, and the market tends to regress to its mean valuation. That is exactly why I begin the year with a relatively large cash position. Many stocks are more overvalued than others and won’t generate the returns as others going forward. I honestly believe my focal areas of tech, particularly in disruptive innovation, and healthcare will greatly outperform due to their potential growth trajectories.
With the markets unmoored from historical reality (along with half the country, by the way) and valuations at historic and unprecedented extremes, it’s refreshing to see some things don’t change, such as the painful short squeeze taking place in the 50 most shorted stocks.
We don’t miss those days, not one bit. So painful to be caught in a nutcracking short squeeze.
Market valuations do not regress to their means until they do. And they will. Someday.
Our favorite stock market valuation metric — market capitalization to nominal GDP — has stocks currently almost 3 standard deviations above their mean valuation, and that even assumes a new era of valuations that began after 1996, where economic power shifted significantly in favor capital over labor.
Moreover, the average valuation for the stock market at the beginning of a new bull market is a market cap of 53.1 percent of GDP. The recent bull market, which began on March 23, 2020, initially started at 105.3% of GDP.
The momentum longs are minting money. This is so easy.
Stunning to see the weekly monetary aggregates (M2) continue to grow at an unprecedented 25 percent year-on-year rate. Not so stunning to see the stock market mania being led and fueled by the money supply growth.
Yet, it is stunning, actually frightening, to see stocks need the 25 percent money growth to sustain its momentum.
This is unprecedented and unsustainable as inflationary pressures are and will surely continue to build even in the flawed official measures. Recent data now show M2 grew north of 1 percent in November month-on-month. The challenge mounts in March when the moving prior 12-month stock of money will be at a much higher base.
The monetary aggregates are also subject to the creation of engodenous money and the vagaries of credit expansion and contraction in the private markets, which are increasingly harder to measure, track, and forecast. This crisis is the first that we can recall where the monetary emissions from the central bank have been so large and come without being in the midst of a major credit crisis.
One could argue, however, that a mini and stellar sovereign crisis erupted in the U.S in early March as the Treasury market began to seize up leading to the Fed’s massive intervention into the Treasury market in mid-March.
We seriously doubt it and the Fed is going to have to step-up big time with QE, non-QE, or let’s just call it for what it is, monetization. —GMM, March 8th
The stock market’s momentum must continue or else.
“There Is No Plateau, No Middle Ground”
The economic situation in a country after several years of bubblelike behavior resembles that of a young person on a bicycle; the rider needs to maintain the forward momentum or the bike becomes unstable. During the mania, asset prices will decline immediately after they stop increasing—there is no plateau, no ‘middle ground.’ The decline in the prices of some assets leads to the concern that asset prices will decline further and that the financial system will experience ‘distress.’ The rush to sell these assets before prices decline further becomes self-fulfilling and so precipitous that it resembles a panic. The prices of commodities—houses, buildings, land, stocks, bonds—crash to levels that are 30 to 40 percent of their prices at the peak. – Charles Kindleberger
S&P500 And M2 Money Weekly Year-on-Year Growth
Inflationary Pressures Building
We closely follow the manufacturing industry, especially the electronics sector, where inflationary pressures are increasing dramatically.
This from the latest global PMI. Some hoarding is actually breaking out in various sectors as producers are expecting higher input prices due to continued supply chain issues and strong demand.
Watch especially semiconductors. Recall our post on how the long secular deflation in semiconductor prices may be coming to end.
…what we believe has been one of the largest factors, along with globalization to the disinflationary forces over the past 30 years. That is the secular decline in the price of semiconductor prices. Semiconductors are the basic building block of today’s economy, as was oil during the industrial revolution. – GMM, Oct 2020
Inflation Expectations
Inflation expectations are also rising across the board.
Stocks and corporate bonds aren’t the only markets that have been looking past the pandemic—the bond market’s gauge of inflation expectations has strengthened back to pre-Covid levels as well. – Barron’s
Surprised?
After all,
Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. – Milton Friedman
The FED
We sense the Fed governors also sense and are growing increasingly concerned about all of the above and becoming reluctant to continue “carpet bombing” the economy with more monetary stimulus.
Federal Reserve Bank of Chicago President Charles Evans said Friday that although the latest job creation data is disappointing, he wasn’t yet ready to call for changes in central-bank monetary policy. – WSJ, Dec 4th
The economy as a whole is running pretty hot (GDP Now at 11.2% Q4 print) and even though the latest lockdowns as COVID cases spike could slow things a bit, economic output should be close to fully recovering its losses from the Q4 2019 peak by year-end.
Two Economies
It is better to think of A Tale of Two Economies, the super-hot economy, which has benefited from the COVID crisis, and the depressed economy, such as travel and hospitality, where employment is still 20 percent below February 2020 levels vs -6.2 percent for total nonfarm jobs.
Labor Market Lagging Economic Rebound
The following chart illustrates the labor market is significantly lagging the economic recovery. Not uncommon but the distance between the two economic indicators is a bit surprising.
We suspect the hit to small businesses — who employ almost 50 percent of the labor force — accelerated automation and technology-led productivity increases are the main culprits, and we also suspect the pandemic has accelerated the disruptions and the technological-led structural economic change.
In other words, nobody knows what the future holds. Us mere humans think linearly and extrapolate past and present to the future, society and the economy progress in a nonlinear fashion.
It’s unlikely the FED is going to slam on the breaks anytime soon but it does sound they are growing increasingly concerned that there is too much stimulus in such a hot economy.
Cruise Missiles, Not Carpet Bombing
We believe economic policymakers will have to resort to strategic precision strikes on the weak pockets of the economy by bringing out the cruise missiles of targeted fiscal policies rather than using the blunt tools of monetary policy. Using monetary policy to fine-tune an economy, for example, especially an economy full of so many distortions, is tantamount to threading a needle with boxing gloves on. Good luck with that.
Still, the question remains how does Treasury finance another round of stimulus without resorting to the digital printing press as demand for its debt securities is so punk at these fake and repressed interest rates?
The Fed’s Dilemna
A 25 percent growth rate in the monetary aggregates is clearly unsustainable but the stock market is addicted and dependent on that liquidity emission, which is driving its forward momentum and keeping the bicycle rolling. Therein lies the rub, folks.
We don’t see a way out and expect the term “inflation” to come back into the lexicon of the market geniuses much sooner than most think.
A further issue to consider is given the substantial imbalances that have built up in the economy and financial market over the years, there is no middle ground on the inflation/deflation spectrum endgame but only what economists call a corner solution. That is lots of inflation or deflation.
What is going to happen to the stock market, for example, if the Fed normalizes monetary policy with the monetary aggregates growing only at their normal rates of, say, 5-8 percent year-on-year? What if the Fed has to keep the monetary spigots on to keep the asset markets afloat? It doesn’t take a rocket scientist to see the rabbit hole monetary authorities have descended in to over the past 10 years.
Finally, we do have to give a shout out to Carol K., GMM’s crack stock picker, noting what she has pounded into us in 2020 — that the stock market is a market of stocks and some stocks, especially the tech stocks of the future, are in a secular bull market. We are thankful that she is on board and acts as a check on our natural contrarian tendencies to bet against the market.
Permabulls automatically bat .700 as the stock market has risen 72 percent of the time on an annual basis over the past 70 years. That’s too easy.
Water is joining gold, oil and other commodities traded on Wall Street, highlighting worries that the life-sustaining natural resource may become scarce across more of the world.
Farmers, hedge funds and municipalities alike will be able to hedge against — or bet on — potential water scarcity starting this week, when CME Group Inc. launches contracts linked to the $1.1 billion California spot water market. According to Chicago-based CME, the futures will help water users manage risk and better align supply and demand. – Bloomberg
While you grapple with the water-diamond paradox, I am wrestling with one of my own: the Bitcoin-J&J Stock paradox. Which is more “valuable?”
Michael Smerconish‘s opening segment in last Saturday’s show is a must view, folks.
It also parrots what Carol K. has been pounding the table about and beating into me over the past year. The COVID crisis has accelerated the trends, both good and bad, and the tech disruption party is just getting started.
Amazon took 25 years to get to half a million employees. It’s now — it’s added half a million in 12 months.
Apple took 42 years to get to $1 trillion in market capitalization. It went from $1 trillion to $2 trillion in just 20 weeks. Take any trend in society and in the business sector, take it out 10 years and chances are we’re there right now. This has literally reached into the future and pulled it — pulled it forward for us, both good and bad. — Prof. Scott Galloway
Anti-Trust Is Coming
The following data is stunning – 82 percent of U.S. households are Amazon Prime Members. That is incredible market power.
I personally think Jeff Bezos, who’s the smartest business person in the world will likely spin AWS prophylactically and my prediction, Michael, is that in the year 2025, the most valuable company in the world will be a recently spun, independent AWS.
The largest most profitable cloud company in the world would have — would be a stock that everyone would own. The most profitable — most valuable company in the world, 2025, Amazon to try and prophylactically stave off antitrust, but antitrust is coming, Michael. – Prof. Galloway
Hope you can view the video in its entirety but if pressed for time go to 2:06 minutes in to catch Smerconish’s interview with Professor Scott Galloway of the NYU Stern School of Business.
It’s no accident Amazon just flipped on their pill pack acquisition and you can now speak to an Amazon pharmacist 24 by 7. We’re going to see, for the first time potentially, healthcare costs come tracking down or crashing down.
I think Amazon’s going to be the fastest-growing healthcare company in the world within two to three years and we’re going to see maybe the potential to get off our heels and play defense around healthcare and go onto our toes and have a level of primary care delivered in the home which potentially or ideally could lower costs and dramatically expand affordability. – Prof. Galloway
Global Macro Monitor 