Markets are exciting. They can also be highly unpredictable, disheartening and, depending on the context, rigged against the vast majority of participants.
In other words, markets are a lot like casinos. And market participants are a lot like gamblers. It’s not supposed to be that way, of course. Equities weren’t conceived as poker chips. They’re supposed to represent ownership stakes in profitable enterprises and thereby a long-term wager on the viability of businesses in which shareholders are partners.
Almost nobody besides Warren Buffett thinks about stocks in those terms. We all pretend we do, but even in-depth fundamental analysis and the most ardent value investors find it a bit too quaint to employ the language of Omaha’s favorite granddad when making the case for a given stock.
In a Sunday note, Morgan Stanley’s Mike Wilson wrote that “investing capital can be an exhilarating and humiliating experience.” Again, like casinos. “Anyone who has chosen this as a career has experienced both, sometimes in the same week, like the one just past,” he added, alluding to the truly wild ride US equities took gamblers on during the holiday-shortened trading week stateside.
The war in Ukraine has absolutely whipsawed equities. Part of the problem is the headlines are hitting in an environment conducive to accelerant flows from dealers, whose hedging needs effectively entail selling dips and buying rips. At the same time, liquidity is poor.
Barring a quick peace agreement between Vladimir Putin and the government in Kyiv (that would be the same government he spent the better part of a week trying to oust by force), the new week will likely to be just as “exhilarating and humiliating” as the last. In fact, even if there is a peace accord or, more likely, some manner of fragile ceasefire, risk assets will probably still be “exhilarating and humiliating” due to the sheer impossibility of trading a headline-driven market, where liquidity is impaired in both equities and bonds and which is currently stuck in a convexity whirlpool.
So, what’s one to do in situations like these? Well, if you ask Morgan’s Wilson, “it’s often helpful to lay out the big factors affecting asset prices and then try to determine what you think you know or can analyze, and what remains hard to determine so it can be properly handicapped.”
If you’ve followed the evolution of Wilson’s framework for US equities over the past six or so months, you know he believes we’ve reached a point where hot inflation and Fed tightening are “known knowns,” as it were, even if you believe we still haven’t seen a deep enough index-level de-rating to justify going all-in on the assumption the worst is over.
What’s not necessarily widely accepted yet, in Wilson’s estimation, is the risk to growth, both for the economy and, in turn, for corporate profits. That’s still a “known unknown,” he mused — something Morgan Stanley believes to be true, but still isn’t baked into consensus.
“Evidence is now building that earnings forecasts are increasingly at risk,” Wilson said Sunday, reiterating the gist of the bank’s outlook for US shares in the near- to medium-term.
The guidance ratio is the worst since Q1 2016, Wilson reminded readers (you can see that in the figure on the left, below). Those of you old enough to remember 2016 will recall that the first three months of the year were somewhat harrowing. Markets were still on edge from China’s surprise yuan devaluation (in August of 2015), oil prices were crumbling and there was palpable concern that the Fed was about to make things worse. It was a deflationary scare, resolved by the so-called “Shanghai Accord.”
In addition, Wilson emphasized that revision breadth is still falling. In fact, he said, it’s “approaching negative territory,” a bad omen considering it generally leads forward EPS estimates.
Although Morgan Stanley isn’t prepared to declare themselves unequivocally right on the growth deceleration thesis, the evidence so far supports their contention.
As for Ukraine, it’s an “unknown unknown.” Geopolitics, Wilson remarked, is “very difficult to analyze and therefore very difficult to price.” What the bank was willing to say about the war in eastern Europe, though, is that it “adds another risk to the mix that’s unlikely to disappear quickly.”
The overarching takeaway from Wilson was straightforward. “In a world where valuations remain elevated and earnings risk is rising, last week’s tactical rally in equities will likely run out of momentum in March as the Fed begins to tighten in earnest and the earnings picture deteriorates,” he said.
the only way I see Putin agreeing to a cease fire is if the West increases air support for Ukraine which would dramatically reduce Russia’s chances for a “quick” victory…hopefully the powers that be agree…
A NATO enforced no fly zone west of the Dneiper River may be more acceptable to EU and Russia when framed as a peacekeeping effort. Putin is gonna want his “pound of flesh” and that may be the part of Ukraine East of the Dneiper which then would give him land access to Crimea and jurisdiction over the more ethnically Russian areas of Ukraine, and the buffer zone between him and NATO that he wants.
Of course no one knows what is really going on behind the scenes.
I’ve been surprised the West mounted a strong response (given its weak knee’d history, and the gutting of the U.S. State Department), and maybe Putin was too, but I doubt it matters too much.
My cynical take: Putin was around during the USSR occupation of Afghanistan and got the U.S. memo on occupation as well. He’ll take care of business in Ukraine and manage it from the top down, not by force of a standing army. What business? the appropriate heads will be on sticks, visible in all the appropriate places. Any unloyal who need not be made an example of, will get paid in Rubles. The chosen will get gold bullion and a piece of “business” to run. Then the cease-fire with a claim to victory in the protection of the poor Russian loyalists who were being abused by Ukraine.
About, the only way to stop Putin is for someone or few of the oligarchs to amass enough power/wealth to displace him and w/o him catching on in time.
Perhaps the Russians could rise up (lots of historical precedent for that), but how hard is that? I can make my comments, but I don’t have to worry that Heisenberg will kill me and my family for what he thinks I’m thinking.
H. You often point out the futility of forecasting and Exh 1 explains much of the problem. I had a minor epiphany when I looked at the chart today. I showed a version of it to my students back in the day, but from a different perspective than you or Morgan. I taught security analysis for a couple of decades and my perspective on the availability of information and its importance was mostly in the context of Graham style company analysis. I read you daily because you and the people your use as inputs do the best job I can access to adding to my lack of knowledge about modern markets. Companies don’t really enter in.
In the context of the exhibit the upper left quadrant speaks for itself. The lower left one is interesting because, as noted, it is a source of competitive advantage. I spent most of my teaching career trying to get my students to think of themselves as independent ventures that need to learn to act like companies and find sources of competitive advantage. Knowing something others doesn’t just mean having inside information. If can can see patterns in the environment others don’t, and you are correct in your assessment, and you act on the information, you can profit handsomely. It doesn’t cost anything to be and act smart. My grad school mentor used to say the key to investing was to figure out something others don’t (he would say get a secret), act on it and then tell everyone you can your secret insight. If no one but you knows the secret the market won’t move.
However, that same mentor cautioned me about the upper right quadrant. He would say if you hear some kind of tip that looks great, act as if you are the last to know and all the alpha is gone. So, learn to find secrets of your own, act and tell others, but if the secret you find comes from someone else, fugettaboud it.
The last quadrant is the trickiest. Nobody knows so your job is to create mechanisms to increase your knowledge (thereby lowering your uncertainty) so you can act sooner than others and be more accurate. This one can cost you money and/or much time. And this is why we (me at least) read you, to get that info and reduce uncertainty.