It’s all too easy to cite a litany of concerns in the course of suggesting a market trading on a nosebleed forward multiple is “sure” to correct sooner rather than later.
One thing I learned from years spent immersed in the social sciences is that there’s always something seriously wrong somewhere. Market participants predisposed to a “constructive” take no matter the circumstances are fond of saying there’s “always uncertainty.” The point being that if the presence of uncertainty is enough to keep you out of risk assets, chances are you’ll always been on the sidelines.
But it goes well beyond mere uncertainty. At any given time, something is falling completely apart. If you look back on the post-financial crisis years, we’ve seen the near dissolution of the eurozone, multiple horrific civil wars in countries that “matter” from a strategic perspective (e.g., Libya, Syria and Yemen), a migrant crisis which, among other things, upended Germany and briefly threatened to deliver France to Marine Le Pen, an overnight devaluation of the Chinese yuan, Brexit and a US election outcome too surreal to believe.
You could (rather easily) argue that when taken together, those events posed a far greater threat to the global economy than the 2008 financial crisis.
And yet, by 2017, equity volatility stateside was the lowest on record, thanks in no small part to Janet Yellen and her compatriots across developed economies. The disconnect is clearly visible on a chart plotting the VIX against various versions of policy uncertainty. The figure (below) is updated from the version I typically use. It now includes the Geopolitical Risk Index developed by Dario Caldara and Matteo Iacoviello. Yellen’s short vol bubble is highlighted in green.
So, where are we now? Well, leaving aside discussions around how structural supply/demand imbalances in the vol complex are affecting term volatility, the most popular market-based measure of “fear” is generally inline with news-based measures of uncertainty. All spiked near record highs during the pandemic but have since calmed down.
But, you could easily argue that things have never been more uncertain (or, colloquially, “out of whack”) than they are right now.
If you like to hear about all the potential pitfalls, BofA’s Michael Hartnett is usually happy to oblige. Commenting on prices in a new note, Hartnett told the tale. “Stimulus has caused immense inflation of Wall Street assets [and] more recently inflation on Main Street [with] July six-month annualized US CPI at 7.8% [and] core 6.8%,” he said, adding that US house prices are up 20% YoY, while inflation in Canada is running at a two-decade high and real estate in the UK, Canada, New Zealand and Australia is on fire.
Not only that, pipeline inflation is “popping” in the world’s two largest economies (figure below) and the “secular themes of geopolitical risk and nationalism [are] crushing globalization,” which is also inflationary, Hartnett said.
And that’s just prices. There are problems on the profits side too. Again, Hartnett was happy to elaborate. The “V-shape recovery was very strong but inflation is now inducing stagflation [as] economic surprise indices are negative in US/China/Japan, auto production is plummeting in US/Germany/Japan, US consumer confidence [was just] smacked to 10-year lows, US home sales are down 13% from the peak and China growth is wobbling,” he wrote.
How’s that for a litany of concerns?
Do markets care? Well, that’s debatable. There were certainly signs of angst this week as “stuff” deteriorated, where “stuff” means everything from the mundane (a hodgepodge of misses on various US macro data) to the existential (Afghanistan collapsed and China’s largest tech companies are now mired in a slump worse than the S&P during the depths of the financial crisis). But US stocks aren’t that far from records.
Looking “under the hood,” so to speak, JonesTrading’s Mike O’Rourke noted that the daily new 52-week lows list for US equities moved above 600 on Tuesday for the second time in the past 16 months. “That’s a far cry from the more than 6,800 new lows registered in March of last year,” he remarked, but observed that it’s a reading “only matched by the Global Financial Crisis.”
Similarly, O’Rourke noted that Bloomberg’s new 52 week highs minus new 52 week lows composite slipped into negative territory. The chart (above, from O’Rourke) shows a one-month moving average.
Hartnett went so far as to suggest that we might see a mini-downturn in the fourth quarter.
The US consumer “has peaked,” he declared. The figure (below) is self-explanatory. It’s compelling to the extent you think it makes sense to match up YoY percentage moves in equities with the same for a PMI.
The Fed is, of course, poised to unveil a taper schedule at some point over the next four months. Generally speaking, I doubt equities are going to digest it well, despite everyone with even a passing interest in markets knowing it’s coming.
The gradual withdrawal of liquidity support will be set against what could be a challenging few months on the public health front. Maybe risk-on seasonality will help. We’ll see.
As for Hartnett, he sees “US fiscal optimism fading” and warned that the perception of a potential Fed policy mistake increases the “risk of an autumn ‘flash recession,’ likely revealed via a sharp dip in global PMIs.”
And here I thought we just witnessed a “flash recession.” After all, 2020’s downturn lasted just two months. Or at least according to the NBER.
H
Looking at your list of global uncertainties, civil unrest, etc., it occurred to me that civil unrest is something of a luxury that mankind tends to afford because certain factions, at least, have enough resources to afford such destructive activities, or they really don’t care what they have, they will simply keep fighting for principles “to the last man,” as it were. We spent 2 trillion dollars and sacrificed the lives of tens of thousands and ruined the lives of many times more, for what? The fear of terrorism? Since 9/11 the worst terrorism we suffered was the storming of the Capital in DC on Jan 6. No one seems particularly worried that we nearly lost our soul in a scant few hours. Nor do nearly a majority of people not vaccinated, unmasked, and relaxed to risk the lives around them so people will pay attention to them. People who tout 9/11 as a motive seem to forget, that was the second attempt at destroying the WTC. The first was a nasty bombing in the garage to try to bring the building down. Where was the hew and cry then? Two trillion wasted in Afghanistan, another trillion in Iraq. We lost, there was no nation building, but we could have rebuilt the US infrastructure with that money. Are we really as stupid as all that? Maybe just indifferent. War, unrest, and the institutions that drive them are mostly silly and wasteful luxuries.
I mean realistically we spent that money largely making a bunch of big contractors wealthy, which was definitely one of the primary goals. It was just an opportunity to sell the population on a huge wealth transfer under the guise of national defense.
Well put, Mr Lucky. And, yes, we are that stupid.
Geopolitical considerations are seldom particularly impactful to the US stock market.
For a given geopolitical risk X, ask “how much will X affect next quarter’s earnings report for” AAPL? MSFT? AMZN? BAC? WMT? JNJ? NVDA? XOM? etc.
It’s often hard to come up with anything much.
Granted, though China and AAPL does come to mind…
The elements of risk Hartnett brought to the table reminded me of (Sec. of Defense) Donald Rumsfeld’s response to a reporter:
“Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tends to be the difficult ones.”
Hartnett was highlighting the first category, the ‘known knowns’ (or risks). And we can acknowledge the second category of ‘known unknowns’ in this context (ie., China could do something, but what?). The third category deserves our ardent attention though it suffers from an epistemological disability (how can one know something they don’t know they don’t know?).
The study of Rumsfeld’s ‘unknown unknowns’ aka “black swans” in macro theory is not without merit. But the satisfaction of having conjured up something hypothetical and “saw it coming” when it happens to occur is not unlike a stopped clock bragging about being right twice a day.
One of the known unknowns is climate change. Who knew 17 inches of rain would fall in hours in a part of Tennessee. Reading the news this morning, it appears that known and unknown unknowns are increasing. Investing feels like sitting in a casino on a lucky streak knowing the place has a high probability of bursting into flame and hoping you’ll smell smoke 5 minutes before it does.