The Week That Matters (4-8 March, 2024)
"Banking is very good business if you don't do anything dumb." Warren Buffet
Finally, the air pocket
In aviation science, air pockets don’t actually exist, but they prove to be a descriptive metaphor when discussing markets. You can literally be “flying” without a care in the world and then, all of sudden, the market drops 500 points, and you are engulfed by fear.
In such tapes, newsletter writers tend to have more confidence in calling a top in markets. TV pundits bring up a date from the past when markets crashed. And old timers like Howard Marks or Stanley Druckenmiller attend a conference and declare trouble ahead. If you don’t have a strong constitution, you tend to panic. But that is almost always the wrong trade in a market with underlying momentum like this one.
This newsletter expected an air pocket a few weeks ago but the market proved to be resilient. The intraday reversal in Nvidia on Friday, however, suggests a few days of red may be ahead of us. The question is should we worry about it? This newsletter doesn’t think so.
A pullback (-5%) or a correction (-10%) now would be perfectly normal. Any turbulence will be temporary and will surely pass - a full blown earnings recovery is taking place, at least in the US, after all. The trick will be to ignore the pundits calling for impending doom. They have a horrible track record. The doomsayers will be the same people who called for a 1987 style crash in September, which is exactly when the equity market bottomed.
Here are some points to remember:
Nvidia has probably NOT peaked. The fact that’s it’s closing in on Apple’s market cap says more about Apple being cheap, than Nvidia being expensive. Nvidia’s valuations are nowhere near “nosebleed” levels. For context, see the multiples Cisco traded on in 1999. At times like this, remember what Lone Pine’s Steve Mandel said: “I don’t need an analyst to tell me a 10x PE stock is cheap. I need one to tell me a 40x PE stock isn’t expensive.”
Global markets are not “euphoric.” In the US, margin positions are the same level they were in the autumn of 2023. In Japan this week the outstanding balance of TOPIX long margin positions exceeded Y4 trillion for the first time since August 2007, which does imply Japanese retail are taking risk. But the margin balance is small fry when you compare it to the Tokyo Stock Exchange’s current market cap. In Europe, the average retail investor is far from being a raging bull for obvious reasons. Even Ray Dalio described the current market, using his bubble gauge, as one of “rational exuberance.”
The institutional allocators (endowments/superfunds/Norges?) don’t own enough growth equities. They have binged on David Swensen’s investment ideas for too long (IRRs are much easier to manipulate than mark to market). This has left them horribly OVERWEIGHT sleeves like private credit (yawn!) and underweight growth (US public tech). If this is 2010 (earnings recovery) or 2016 (multiple expansion due to a change in policy in China), they will be forced to lift offers in FAANG stocks soon enough. Look for big block trades going through on the relevant ETFs.
The market is showing signs of broadening out. Consumer discretionary stocks did well in February. Industrials are printing new highs on good earnings and buy backs (see Daimler Trucks) and even Russel 2000 is looking to potentially explode higher. YoY EPS growth of Russel 2000 has turned positive for the first time since September 2022, according to Bank of America. Interestingly, large cap tech laggards in Asia like Samsung and Hynix also tried to rally mid-week. The US growth accounts clearly need to put money to work.
Steve Mnuchin is no schmuck
When previous Treasury Department Secretaries got together and penned an article in the New York Times in 2021 on how to fix tax evasion, the extent of the reach of Goldman Sachs into high profile government positions became clear. Goldman Sachs alumni were well represented amongst the authors (Paulson, Rubin).
Getting the Treasury Secretary job would appear to be a rite of passage similar to Japan’s system of Amakudari (Descent from Heaven) where bureaucrats get lucrative jobs in the private sector when they retire. The US Treasury Secretary gig doesn’t pay the same as a senior role at Goldman’s but the tax breaks and the connections clearly make up for it.
What is also interesting was the Treasury Secretary at the time was none other than Steve Mnuchin, another Goldman Sachs alumni. The author thinks Mnuchin was one of the best US Treasury Secretaries since Geithner. We stood on a deflationary cliff in March 2020. We needed swift and adaptive thinking. Mnuchin delivered.
The key point here though is Steve Mnuchin is THE establishment. He has been in the mix since he was a kid as his Father was a Goldman Sachs partner too. He has his ear to the ground and has proven himself to be a successful business man, even in the shark infested waters of Hollywood.
And so, the fact that his private equity firm backed New York Community Bank this week in a USD$1 billion deal should not be overlooked. The author suggests it’s a reason to take a collective sigh of relief about the state of US banks. As Powell noted this week, there are risks and some banks will fail partly due to him embracing the ghost of Paul Volcker but perhaps there is light at the end of the tunnel.
When speaking to the press, Mnuchin this week ably explained how he intended to work through the bad loan issues of his bank. What was perhaps most exciting was his confidence that rates would come down soon enough. That has weight, no? Presumably he still has Jerome Powell in his speed-dial.
Investment funds tend to hunt in packs and buying banks with good franchises in distress can be an incredibly profitable strategy (isn’t that Jamie Dimon’s true superpower?). The author would suggest we will see more activity in the space from private equity in the coming months.
Central Banks: Snatching defeat from the jaws of victory?
Two central banks currently matter: the US Fed and the Bank of Japan. The ECB is merely a mouthpiece of the US Fed.
Christine Lagarde this week noted progress had been made with inflation but she also stated, “we are not there yet.” This worries the author. Lagarde has herself criticized the economic models central banks use. If they rely too much on them going forward, we risk the hard landing that the bears have worried about.
Many commentators this week suggested both Powell and Lagarde were on the whole dovish. To a certain extent, that’s fair but their language continues to sound like the Fed rhetoric of old. The focus is always on jobs and wages. The narrative spends little time on the fundamental reason why CPI might stay higher than hoped and that is monopolistic practices in certain industries like healthcare.
The Fed has an awful track record of managing the business cycle and if it doesn’t admit there are other reasons for inflation other than wages then they might mess it up again. Conditions are too tight at the moment for small businesses and the middle class. It’s time to cut rates.
Unfortunately, we have been indoctrinated by Friedman and his ilk to believe wages have to stay low. This was evident recently when Kyle Bass complained about his $85 dollar breakfast at a hotel in New York City. He didn’t think to complain about the massive increase in the room rates over the last 10-15 years? It was the cost of making the food that was the problem. Just as with his views on Japanese public debt, he kind of missed the point.
Such thinking is particularly interesting currently as Japan is trying to do the opposite to get its economy out of the hell that is deflation. Wages matter and help to create a healthy economy, where people are optimistic and are willing to spend. We are seeing old school companies like Cosmo Oil in Japan raise wages ahead of the April wage negotiation this year. And it’s clearly impacting life in Japan. February sales from the retailers were quite healthy. The Japanese consumer has re-discovered his or her joie-de-vivre. It’s the Chinese consumer now, who is going into his or her shell.
The strong personal and corporate balance sheets have helped us avoid the recession we saw in the early 1980s when rates were raised too high too quickly before but at some point, things won’t go so smoothly. We might even have a financial crisis.
The US must also consider moving forward with a broader discussion about labor representation. There were signs early on in Biden’s administration that the unions were coming back a little but somehow it lost momentum with all the nonsense about “sticky wages.” Australia might have gone too far with its union movement but the US has gone too far in destroying its one. To be clear, the author is not a socialist but some labor representation just makes good sense.
Deflationary forces are everywhere. China, for example, will become a manufacturing superpower now (Germany will suffer the most - machinery, chemicals, cars) and export much more than it consumes over the next 10 years. The social contract in the US just won’t work like it has done over the last 40 years going forward. Something must change. The good news is Yellen has been thinking about a strategy for years.
As always, thanks for reading. I am off to Japan for a week tomorrow to visit Japanese small cap industrials and Japanese biotech names. Eli Lilly has been the poster child for non-tech growth over the last few weeks in the US and 4507 Shionogi didn’t disappoint in Japan either. I think there might be some very interesting names in Japanese biotech going forward but it’s time to do the work. All the best in trading, business and family this week. None of this is financial advice. Do your own research!
Best regards,
Mateen