The Week That Matters (Oct 31-Nov 3, 2023)
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” Benjamin Graham
Bull Market in Pessimism (Part 3)
Part 1 of the author’s series, “Bull Market in Pessimism,” was written at the end of September 2022. The author argued people were being too bearish equity markets, especially software names.
Silicon Valley had already thrown in the towel. Sequoia had started writing bearish macro reports even though they are supposed to be secular growth specialists. And Chamath Palihapitiya was calling for a venture capital winter. His apparent bipolarity was nauseating. Wasn’t he pushing SPACs a few months before?
Old time fund managers, who were lucky enough to be in the right place to have milked the equity bull market from the early 1980s, didn’t help much. They were, like veteran politicians, part of the generation that had caused many of the problems being faced today by young people. All they could add, however, was the world was about to go to hell, as if calling for a collapse in share prices would be a suitable coda to their careers. It was really annoying.
Part 2 was written a couple of weeks ago as similar to September 2022, it was hard to get anyone to say anything positive about anything. To be fair, the Middle East situation looked very fragile (it still does) and the Fed had just stated interest rates would be “higher for longer.”
Part 3 has been written to again counteract all the bearishness and point out what could go right if you are looking to allocate capital to equities. The author would like to therefore restate his view on the markets:
Recent Market Volatility is Normal
The market volatility that we have seen since the start of September is perfectly NORMAL during the third year of an election cycle. If anything, it is simply a repeat of the market tantrum we saw in the December quarter of 2018, which was the last time Powell took so much liquidity out of the system.
Inflation peaked a long time ago
Inflation is now in the rear view mirror. COVID was a once-in-one-hundred year event that clogged up supply chains. That issue has more or less been solved (see what AP Moeller Maersk said about shipping rates last week). CPI and Core PCE tend to lag reality but all real time indicators suggest prices are heading lower again.
Yields are peaking
Yields are unsustainable at these levels if nominal growth is slowing. Name one macro research firm that’s positive about growth next year. Talk of 7% yields or higher is, therefore, just plain silly. Powell has sacrificed high nominal growth and plenty of jobs for an arbitrary inflation target (2%), that is serving no-one! And he is causing as much damage as Volcker did in the early 1980s, which will ultimately lead him to cut rates in the New Year (200 bps possible in quick succession?)
The US Bond Market is the Gold Standard
Margaret Thatcher was wrong. The housewife analogy Thatcher often used about managing a country’s finances was politically astute but it always held little sway in the real world. We are worrying too much about the USA’s debt position. There will always be buyers of US debt - there is no real alternative. Curiously, the Friedman ilk, despite being behind the household analogy Thatcher and Reagan used, never talk about the income side of the ledger for the US. How big do you think the GDP of the US will be in 2050, especially if we get a much needed New Deal in the 2020s? (Yes, it can happen!)
We live in a Victorian Age of Technology
Silicon Valley might be licking its self-inflicted wounds but there are plenty of publicly listed companies growing like weeds on NASDAQ at reasonable valuations. (As Lina Khan of the FTC is focused on the large deals, aren’t a lot of the sub $5 billion names acquisition targets?) At the bigger end of town, of course, we are also blessed with incredible leaders that we just didn’t have in the 1980s (compare Jack Welch with people like Nadella, Cook or Zuckerberg) and we have businesses like Apple - doesn’t everything grind towards it?
Low Interest Rates Work!
Interest rates are a function of the amount of savings in the world. As John Maynard Keynes noted in his 1930 essay, Economic Possibilities for Our Grandchildren, for most of history, savings were non-existent. That explains why throughout history they tended to be higher. Today is different. The household wealth of the USA is estimated to be $160 trillion! Add in China and Japan and the numbers get HUGE. We need that money in productive assets, not sitting in saving deposits in commercial banks. Look at what is happening in Japan right now to understand how a little inflation and the resultant search for returns can improve efficiency of capital allocation and in turn help a nation regain its joie-de-vivre!
Time, therefore, to be max bullish?
The Middle East remains a huge concern but the author would like to suggest we might see a strong seasonal move higher into Christmas and beyond. The bear market in bonds might be over (see channel break out), oil is declining, despite the tensions, and DXY might have also peaked.
Positioning is also extremely bearish. The author pointed out the extremely high put to call ratio a couple of weeks ago but Goldman Sachs data suggests hedge funds have increased stock short positions for 12 consecutive weeks, the longest streak in history!
We saw evidence of some of the impact of HF positioning last week. The author bought FSLY on optimism the earnings would be good. They weren’t amazing but it ripped on volume for the simple reason there weren’t many sellers left and the numbers were good enough. Unfortunately, the author was not long ROKU, which did print some good earnings. This caused the stock to squeeze 30% on the day. It had been a hedge fund favorite short.
On the flip side, BILL, which was still a hedge fund favorite long until last week, got hit hard on slowing growth. It would seem that even the most celebrated B2B SaaS companies can’t keep growing the way we had hoped. One thing the Silicon Valley “Vertical SaaS” narrative might have underestimated is the willingness for clients to go through some pain to switch to cheaper alternatives but that’s a topic for another newsletter.
Other bullish thoughts to mull over
If you are willing to read through earnings report, there is actually a lot to like right now. Here are some bullet points to ponder:
Qualcomm suggested “ the China handset market is stabilizing.” That’s big, no?
TSMC suggested a couple of weeks ago that they would see “healthy growth in 2024.” More signs that the semi cycle is bottoming?
AI Monetization starts this month with the Co-Pilot launch. The street is saying Microsoft could get $14 billion in revenue from it! That’s what they paid for their stake, no?
Should old hedge fund managers be forced to retire from public life at some point?
The author has argued many times that if you want to make money, it’s best to tune out the old timers. With the exception of Charlie Munger (his Apple call saved Berkshire from becoming GE), their collective track record since the GFC has been horrible, whether it’s Ray Dalio saying “cash is trash” at market tops, or GMO’s Jeremy Grantham consistently claiming the world is going to end.
Stanley Druckenmiller is the perfect example of someone, who was arguably great once, but should perhaps think about retiring from public life. He hasn’t really been that good since 2000, to be fair! That’s nearly a quarter of a century, if you’re counting. And the author can’t help feeling Stan only crushed it because the real GOAT of risk management, George Soros, took him under his wing.
As pointed out a couple of weeks ago, the last time he went on record saying US equities would experience “a lost decade in equities,” akin to the 1990s in Japan, he more or less called the bottom in October 2022. Only a week or so after he spoke at the Sohn Hearts and Minds conference, the market began an 800 point rally. It is the author’s opinion that Stan might have got his timing horribly wrong again by claiming “equities are not the place to be” in a recent fireside chat with another former titan, Paul Tudor Jones (are his best days behind him too?).
Stan is right, to be fair, to say “things are going to break.” Jerome Powell will end up causing significant damage with his embrace of all things Volcker, just as Volcker himself did in the early 1980s - that’s why Ronald Reagan wanted him gone. The delayed impact of his excessive rate hikes will cause a problem somewhere. And he will have to cut to save the economy, which should be supportive for large cap tech compounders with high ROIC. The author hopes to add to Microsoft and Apple this week for that reason. Let’s go!
As always, thanks for reading! I am really enjoying my new role introducing amazing fund managers from overseas to institutions, family offices and wealth managers in Australia. It’s so much less stressful than dealing with tech founders, if I am honest!
This week I had the privilege to be on a road show with the oldest Venture Debt firm in Silicon Valley. (Thank you for attending the lunches if you did). For me, it’s the perfect strategy to play Silicon Valley right now. It provides downside protection and yield while giving the investor equity upside at the same time for some of that J-Curve magic that Silicon Valley can sometimes produce. I will, no doubt, be chatting with some of you this week about it.
As always, none of the above is financial advice. Please do your own research. I wish you the best with family, business and trading this week.
Best regards
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.