I could have written ten articles today.
Following from Friday’s market update, there are a lot of questions and themes I’d love to discuss and figure out with you.
So today, I’m going to trial something a little different – a series of ten 100-word (ish) articles.
Ambitious, but I’m looking forward to it.
- The anniversary analogy
I find it odd, and fascinating, that this week has seen a scary plunge in equity markets… because it is eerily precise as a one-year anniversary of the first week of the corona crash in March last year.
Between 24 February and 1 March 2020, markets fell by around 10% – the first of many.
Back then, it felt like the markets finally realised that the tsunami of coronavirus was breaking on our shores, and panicked in unison.
This feels the same, but replace “coronavirus” with “inflation”. It’s been coming for months, but for some reason investors could only see it when it almost literally slapped them around the face.
I also wonder about an eerie series of technical formations which came together this week.
I actually saw someone sharing a warning about this two weeks ago.
It looked like this:
One of the things which interests me most about investing is the human psychological element.
We are sadly predictable and prone to repeat mistakes, and so it doesn’t surprise me that markets often form patterns and formations which seem coherent in some way.
Does any of this mean anything? Maybe.
- And the Lord said…
On Tuesday morning, things looked as bad as I’ve seen them since the worst days of the March crash last year.
But with the chairman of the Federal Reserve, Jerome Powell, who delivered his monetary policy report to Congress last Tuesday and Wednesday, I felt some calm was in order.
Bond yields reached threatening levels across the world, and Australia restarted its bond buying programme and Christine Lagarde of the European Central Bank made helpful noises.
Powell dutifully did the same.
He spoke about carrying on until the Fed’s two-point mandate was reached – full employment and price stability.
Well, the US so far from full employment that he’s going to have to keep supporting markets for quite a while. Getting there is likely to screw up price stability. I think he’s going to have to choose one…
The rally in stocks he briefly engineered last week (Tues/Wed) faltered all too soon, with the brutality returning on Thursday.
A key thing to watch is whether value and cyclical stocks – banks, energy, utilities, commodities and the like – can benefit from rising yields, or whether falling tech stocks will drag them down too.
Tech, growth, and unprofitable small caps will suffer the most if yields carry on rising.
On Tuesday, there was an extreme rotation – I believe that energy outperformed tech in the US by 15% in the first three days of last week.
But on Thursday, the rotation morphed into a correlated downturn. The tech-heavy Nasdaq and the small cap index Russell 2000 did worst, falling 3.7% each, but everything suffered. The FAANG-dominated but broader S&P followed suit, down 2.4%, while the more industrially weighted Dow Jones fell by 1.8%.
Energy’s outperformance (green) stuttered, while tech (red) carried on lower:
Can you tell when Powell gave his speeches? Clue: tech rallies once he’s on air.
Rotation or correlation is a key them to watch, but I doubt how long rotation can last if tech truly suffers.
- What about gold?
This is tricky – I wish I had more words left.
Bond yields are rising. One key consideration for investors is, “If I can get X yield on bonds, why would I own Y or Z?”.
Y and Z are stocks and gold.
With US bond yields rising, they become more appealing to buy, relative to stocks and gold.
The question for gold is whether inflation will run higher than bond yields in the months and years to come.
This is complicated and uncertain, and needs a closer look – I will do so on Wednesday.
- Noah’s ARK? I doubt it
Cathie Wood’s ARK Invest brings up mixed feelings for me.
Am I allowed to say that it’s great to see an incredibly successful investor who isn’t an old white guy?
She has brilliantly called a raft of big trends in tech, clean energy, transport, and has profited handsomely.
We must recognise her incredible success first.
However, her bullishness is too extreme for me. She encapsulates Howard Marks’ four worst words in investment – “no price too high”.
ARK Invest is now a tech whale. It owns huge chunks of a great number of small companies with no profits.
It has been the recipient of incredible waves of capital inflows, and has duly invested those.
However, last week saw record outflows.
I fear that her success has created a monster, and that ARK Invest is now akin to a passive fund. If redemptions cross a certain threshold, her forced selling of securities to meet those will harm the very sectors she loves, accelerating the downturn and loss of confidence in her funds.
She is now big enough to fail.
- MOVE, VIX and VAR
Volatility is a big factor. Expected equity vol is measured by the VIX, in bonds, it’s the MOVE index.
One thing which was interesting was that the MOVE index jumped a week before the stock market registered any problems.
Just like the charts I shared last Friday, bonds picked up on the trouble first, with the MOVE index (shaded green) spiking a full week before equities (the VIX – red line) picked up the scent of inflation.
This is worth paying attention to, because while stocks have led the tango to new all-time highs, watching bond markets closely now seems wise, if you want an early warning system for what might happen in stocks.
This was freaking me out back on Monday, as yields rose, the MOVE had spiked and bitcoin was falling.
If this were a cake recipe, it would be a horrible, unpleasant cake with plain flour, and no baking powder.
It doesn’t bode well for a big rise…
- 20 years later…
When Jeremy Grantham came out a month ago and described this as the biggest maddest bubble, up there with the best of ‘em, he described a very interesting phenomenon from the dotcom crash.
It has captivated me ever since.
In 2001, he said, markets didn’t roll over in unison.
In springtime, the most speculative small names in the dotcom bubble fell first. Your pets.coms and the rest.
But they were tiny, and few people cared or noticed.
Then the mid-sized bubble stocks started suffering. Months passed, and the indices kept rising. Other sectors and stocks picked up the slack. People were selling bubble stocks and rotating into value, or unloved assets.
Then, by mid-summer of 2000, the Cisco’s, the Amazon’s and Microsoft’s started to get hit.
Six months had passed since the market had “taken out and shot” the super speculative small caps.
Internet and tech were a third of the market in 2000, and only once the very biggest names were getting taken out did the rest of the market catch on.
Then, and only then, did the indices start rolling over in unison, starting their long road to 50-90% declines.
This year… the FAANGs, which had supported the market through thick and thin since the twenty-teens, stopped surging last September when the vaccines got announced.
Then in January, on 8 January in fact, all the super speculative large caps stopped rising – Tesla and friends.
Now it’s spreading again, and small caps, bitcoin, clean tech – everything has caught the bug. But still, the major indices are rolling on, “rotating”.
Makes you think…
What could derail markets?
A threat to the re-opening narrative perhaps? That’s one view.
People have become infatuated with the vaccine/reopening narrative – and quite understandably. I am too – being beside myself with excitement for longer, warmer, sunnier days and all that might come with it.
In the US, cases, hospitalisations and deaths are all falling.
However, very subtly, cases of the B117 (Kent) variant are doubling every ten days in the US.
British readers will know how this ends – in December we all thought the second wave was falling just the same way the first had.
And then the Kent variant took over, and our third wave emerged from the downtrend and exploded higher than anything we’d seen before, leading to a long winter lockdown.
Americans beware, the vaccine rollout gathers speed, but the B117 variant poses an incredibly significant threat – 1.5x more virulent than the original.
Markets have moved on from Covid-19, but it may rear its ugly head once more before we are truly done with it.
- The paradox
So a threat to the reopening could derail the positive narrative in markets.
However, that very reopening narrative could itself derail the everything bubble.
You see, for a year now we’ve all been wondering how on earth stock markets can be so high while the economy is so clearly down in the dumps.
It made no sense.
Well with this new paradigm, perhaps the inverse will happen when economic reopening occurs and growth returns?
Get ready for some headlines wondering how stocks can keep falling when the economy is looking so good again.
- The Paradox: Part II
“Kit, that’s silly.”
Hmmm… I wonder.
Back in April 2020, I wrote that everyone was waiting for Covid-19 cases to peak for stocks to bounce.
I believed they should be looking for a deceleration in case number growth, and said that we had perhaps already seen that point.
That was on 1 April 2020, within a week of the bottom in Markets. Here it is.
I also wrote that people had wrongly bought the narrative that markets were only crashing because of Covid-19. I felt markets were already overvalued and due a large pullback – Covid-19 was just the proverbial final straw.
I suggested though, that if people had mistakenly bought the Covid-cases-up-markets-down narrative, that the reverse might (also mistakenly) be true once the deceleration had become evident.
That people would happily buy stocks as long as Covid-19 cases carried on lower.
This turned out to be true and by the time second waves came, we had vaccines to cheer about.
Stocks have rallied higher and higher on vaccine-led reopening hopes.
But what’s that old saying – buy the rumour, sell the news?
It was true of the Lucid Motors SPAC (special purpose acquisition company) deal last week, when the SPAC rose 500% on the rumour that it might merge with Lucid, and then promptly fell 43% as soon as the deal was announced.
I wonder if it might be true again here.
That markets have been rising in expectation of a return to normality – but that the very thing investors have been hoping for will be the thing which brings down the curtain on what I still see as a bear market rally since March.
The reopening is forcing inflation expectations higher, dragging yields up with them – and we saw last week what a relatively small move in bond yields can do to the frothier parts of the stock market.
It would be ironic, poetic, and incredibly logical all at the same time.
Well – there you have it.
Ten Hot Takes on last week’s incredible market action.
If any of them come true, I will refer to this article constantly in the future and claim above-average foresight and intelligence – just to warn you.
Feel free to remember the ones I’m hopelessly wrong about too.
Editor, UK Uncensored