Markets: This Week is Make or Break
This newsletter published a post at the end of September 2022 which argued that we were experiencing a bull market in pessimism at the time! Stanley Druckenmiller had just claimed that there was a high probability, in his mind, that the market was going to be flat for 10 years, “the kind of market that took place between 1966 to 1982.” He was also adamant that there would be a hard landing in 2023. (We are still waiting!).
The idea of a Japan style “lost decade for equities” in the US was too good a soundbite for the media to ignore. And it naturally milked it for everything it was worth, resulting in people selling some of their equities at the lows no doubt. They even quoted one trick wonder, Michael Burry, who was shorting some stock at the time that he claimed would go to zero (it didn’t by the way!).
Against such a backdrop, it felt lonely to be bullish but ultimately it was the right call. The market found a low mid-way through October and we were off to the races for eight months while VIX seemingly went lower every day! It was the perfect set up.
The author would like to suggest we are potentially in a similar situation now. It just feels even more isolating to be bullish. But before mentioning the reasons why it might pay to be optimistic, let’s deal with the obvious risks this week:
Risk #1: Israel goes too hard
If Israel retaliates too aggressively, the whole region could get involved. That would be bad! And the market could break lower on volume. But there are a few reasons why, in the author’s opinion, it might not happen the way most people think it might.
Israel, behind the scenes, is probably under intense pressure from the US and even Russia, not to go too hard (Netanyahu has visited Putin many times over the last couple of years btw).
It’s easy to forget that before Putin’s invasion of the Ukraine, Biden gave every indication that he would be focused on US domestic policies. He talked about infrastructure and education as an investment in one speech (that hadn’t happened since the 1960s?). He gave an almost Kennedy-esque speech in the United Nations about peace and non-intervention.
Of course, the war lobby (“The Blob” as Obama used to describe them) is strong. And they have tried to dominate discussions since the Ukraine invasion in February 2022, but there’s an equal faction behind the scenes in the US, who want to focus on such things as reshoring, infrastructure spend and wages! (The Yellen camp)
Biden might have built his career in part being close to AIPAC but there is presumably less desire to get involved than we think from a US perspective. An oil price of USD$150 wouldn’t be good for election season next year either.
Netanyahu is also under pressure from within. Israel is a robust pluralistic democracy with many divergent voices. The author has often noticed that his friends who live there are more conciliatory than the ones who live far away in places like Los Angeles. There is a lot of frustration with Netanyahu in Israel. He has to tread more carefully than we might think.
Israel has to keep the global community on its side. John Mearsheimer has argued that Israel started losing its international standing after its invasion of Lebanon in 1982. The author disagrees. Israel’s standing in the world arguably peaked in 2005-2006. Things started to falter after the Lebanon 2006 war. Israel cannot become a pariah state. It serves no one.
Israel has nuclear weapons (allegedly) and an effective secret service but its army has not been that proficient in recent conflicts. Gaza could become a quagmire for them. And there is no public support from within the US to provide troops.
The future of Israel has to be through normalization of relations with its neighbors. The money from the US is considerable every year and it helps but Israel has to start doing business with countries with Saudi Arabia and the UAE in scale. Yuval Harari made a great point about Poland, the Ukraine and Lithuania. It didn’t go the way of the Balkans in the 1990s because of a decision to look forward, not backward. Sometimes tragedies like what occurred on October 7th can result in a new dawn of thinking from all sides. Let us hope.
Risk #2: The bond market breaks above 5%
Fed Chair Jerome Powell walked a narrow line in his speech before the New York Economic Club on Thursday. Did anyone notice he was using prompt cards btw? He is not in the same league as a Janet Yellen or an Alan Greenspan.
His measured response obviously unnerved the bond market. His “higher for longer” messaging implied that there would be no Fed bail out soon and conditions would remain incredibly tight.
Could yields nudge higher this week? One would imagine so but you have to assume they are nearing the peak given slower inflation and potentially weaker growth going forward. And of course, Powell can and should pivot soon. How much damage does one man want to create?
As discussed before, there is no justification for rates to be this high. It’s almost preposterous and shows how limited the Fed’s arsenal is in reality. Powell even referred to interest rates as being a blunt interest last week. Hello!
Risk #3: The S&P Chart
Technically, things look vulnerable. It’s make or break this week. If we do breach 4200 on the S&P, there might be some heavy selling. But here’s a couple of things to think about:
Yes. If interest rates stay high, valuations might be vulnerable but are large cap tech compounders (the Magnificent 7) really that expensive anyway? And won’t the smart money start naturally anticipating a pivot soon from Powell? If Powell continues to cause havoc like Paul Volcker did, doesn’t that mean he will need to take rates much much lower in response? Are negative rates even possible in 12-18 months? The author knows that’s punchy but the Fed has made a lot really bad decisions over the last 40 years, hasn’t it? “Higher for longer” seems to be one of them.
Positioning surely plays a role. Bank of America published a report pointing out everyone is already positioned bearishly. The put/call ratio is at highs. Cash as a percentage of investible assets is at levels not seen since March 2020. People have been net sellers into the rally from October 2022. In some ways, it is similar to how the move higher in 2009 moves played out. No one really believed in a bullish environment until maybe 2011! It’s worth noting, as mentioned many times before, that people like George Soros and David Tepper made a lot more money playing the recovery than most of the people, who crushed 2008.
Now let the author explain why it might pay to buy on any weakness:
Reason #1: “Higher For Longer” is an empty promise
The author is not a fan of Jerome Powell. He believes he is making the biggest monetary mistake in two generations. Paul Volcker was not the hero people say he was. He caused two recessions unnecessarily in the early 1980s. That’s why Ronald Reagan hated him.
The reality is the Fed is fairly limited in what it can do. It can manage liquidity. It can adjust the cost of capital and it can try to influence the market with its words. Even though Alan Greenspan was a genius at coercing investor sentiment, and Powell is pretty average, for some reason, people in polite circles have attached great importance to Powell’s statement that interest rates will be “higher for longer.” The author believes the statement is meaningless. The Fed can and probably will change its stance in a heartbeat.
Financial conditions are tight right now in the economy. And the bond market moves last week are making things tighter. There is no point in crushing businesses and individuals until the pips squeak. A nasty recession will serve no one apart from cashed up private equity firms.
The difference between Powell and Volcker is Volcker had an almost religious conviction in what he did. Powell, as discussed above, is just blowing in the wind. And the winds are bound to be shifting soon. Do you think he is close to a pivot? The author thinks it’s just a matter of time.
Reason #2: Inflation has been beaten
Inflation remains an unnecessarily emotive issue. The press love to talk about the price of milk going up but spend little time concerned about Mum and Dad losing their jobs (isn’t inflation 1000% then?) or the middle class (they have all the debt) losing their marriages due to financial stress.
We have been indoctrinated to believe that all inflation is bad by the Friedman ilk but inflation can be a force for good. Look at Japan. Deflation favored the old and the already rich. It crushed the young and the brave. Inflation can and often does bring a joie de vivre to a nation (see company formation numbers in Japan). And it helps the indebted (isn’t all debt nominal?). And it has also been present in some of the best economies the US has ever seen (1980s for example).
The author has consistently argued inflation would be transitory. By 2030, we will look at the recent pick up in prices as a mere blip. We are in a deflationary environment and we have a growth problem. The only way out of it is a New Deal of sorts. Japan has provided a blueprint for the world to break out of deflation but the author will revisit that idea again at a later date.
The Earnings Recession is Over
It was easy to miss TSMC’s earnings this week but it beat its estimates and raised its forecasts. Importantly, management seemed more bullish on a 2024 recovery as inventory digestion approaches the end, rush order increases and PC/smartphone demand stabilizes. That’s a big deal. It suggests to the author that the semi-conductor cycle has bottomed. AMAT has also seen broker upgrades of late. If things don’t crash this week, look for leadership from semis on the recovery?
How AI will be monetized should start to become more clear as the week progresses. In November, we get the launch of Microsoft’s benchmark pricing. In its earnings report this week, it just needs to start showing growth in its estimates for the impact of AI on its business. AI could easily return as a major theme. Someone paid a big price for Open AI shares this week. Things could get silly again quickly.
Re-shoring has been a boon for both the Japanese and US economies. We will see that play out hopefully in the earnings from the likes of Caterpillar, which reports at the end of the month. Again, if you think the cost of capital might drop, aren’t some of the global plays interesting given their free cash flow generation?
The Future is Japanese?
The author had a great week taking one of the major Japanese asset managers around Australia to meet superannuation funds, wealth managers and family offices. Interest levels were strong. The Japanese equity story is starting to filter through to the masses.
The author believes Japan, Nasdaq and India are the great equity stories of the 2020s. Given his affinity with Japan, it is amazing to see the country seemingly be on the up and up. First, it broke out of deflation and for the last few years, it has experienced nominal GDP growth. That is huge and changes EVERYTHING. Companies can raise prices, companies can improve margins and most important, companies can start making forward thinking decisions about their businesses, not just spend time cutting costs.
It was wonderful to be with the asset manager but it did highlight the importance of political leadership to the author. For this newsletter, Shinzo Abe and Haruhiko Kuroda are the most important leaders thus far of the 21st Century. They had a vision and executed a plan. Their country is now reaping the rewards. To be fair, they didn’t operate in a vacuum. They were supported by talented civil servants in the Japanese ministries. Japan has not followed the West and outsourced government to consultants. It still trains its own staff and that also can make a huge difference.
The author’s Mother country of the UK could do with such leadership. Unfortunately, something has gone wrong. Any politician with something to say gets sidelined in favor of people who are easily malleable (Boris Johnson?). And unfortunately, it has embraced consultants as a way to govern, arguably more than any country in the world. The UK once had a “Rolls Royce Civil Service.” Today, it’s a mere shadow of its former self. How do we build nations without government administration professionals? We forget how important government is for innovation and growth. Israel would not be the success it is today in technology without an effective top down policy to build market leading companies. Why is that so hard to understand?
As always, thank you for reading. To be clear, I have very little risk on at the moment as it’s too tough to call. I apologize for not writing the last two weeks but things are very busy business wise. I wish you the very best with family, business and trading. Here’s hoping for peace.
Shalom (Hebrew) , salaam (Arabic) and shlama (Aramaic).
Mateen
DISCLAIMER: None of this is financial advice. The opinions expressed are purely my own opinions and it is imperative for you to do your own research. They do not represent the views of any company I am associated with.