“This cross-asset price rally is about to become a ‘wealth effect’ problem for them again,” Nomura’s Charlie McElligott said Friday.
“Them” is the Fed. Policymakers are now staring at a Nasdaq rally poised to spin out of control thanks to an escalating A.I. “mini bubble,” as BofA’s Michael Hartnett dubbed the Nvidia-inspired melt-up.
The burgeoning frenzy is starting to manifest in anomalous outcomes, including one of the largest monthly performance disparities between big-tech and the S&P since the dot-com bubble.
The Nasdaq 100 is now trading on a ~26x forward multiple versus 18x for the broader market. That’s well above the post-dot-com average, albeit not as rich as big-tech traded during the height of the pandemic stay-at-home bonanza.
“Left-tails are turning right-tails or non-events, so all of that ‘forced’ (over)hedging for the ‘debt ceiling x-date / US government default / regional banks profitability crisis = credit crunch / hard recession’ calamity scenario is being unwound, and perversely acting to propel assets higher, to the chagrin of risk bears, recession doomers and hedgers alike,” McElligott wrote.
The clearest expression of evaporating risk premia is the veritable collapse in vol-of-vol. The ~27-vol one-week decline is “a pure expression that ‘crash’ / skew is being offered back to the Street from clients unwinding their bleeding hedges,” Charlie went on.
The five-session drop in VVIX is the largest in a year, and falling skew suggests tails are getting unwound fast.
All of this is potentially perilous for a Fed which needs to protect whatever gains they’ve made in the inflation battle. And that’s really the point: They haven’t gained much on the services side, where price pressures are stubborn. A risk rally that rekindles the wealth effect could make the situation worse.
Of course, nothing gets the animal spirits stirring like the specter of a technological epoch, and with so much dry powder (i.e., sideline cash previously content to collect 5% while waiting on various storm clouds to clear) sitting around, FOMO could turn into “FOCUS,” McElligott cautioned.
“Spot equities continue climbing the wall of worry and increasingly creates FOMO or, as I am now calling it, ‘FOCUS,’ i.e. Fear Of Cash Underperforming Stocks,” Charlie wrote.
That fear, he said, creates “upside force-in risk,” and it’s already showing up. Note that the tech inflow mentioned here on Friday morning was a 100%ile event.
“Although the Fed is telling us that they are being ‘prudent’ risk managers as it pertains to ‘credit crunch’ fallout from the regional banks profitability crisis, it sure seems like they are yet again in the ‘bubble-blowing’ / ‘positive wealth effect’ business,” McElligott wrote, before gently suggesting that a Fed which countenances market froth is a Fed that risks “creating ‘sticky inflation’ issues down the road.”
Easiest solution is QT – amp up the quantity and pace – why they choose not to do this is a total mystery
Hanging on to the soft landing hopes.
I think not everyone at the Fed is feeling like tempting a soft landing. At least I hope a few smart people there feel in their bones the prospect of containing inflation is perilously close to getting away from them. Because it is. If it’s not, then things really are different this time. I am inclined to believe that things are same as they ever were. If I am correct, as hard as that may land for our economy, it will mean that things, markets, economies, still make sense.
The only way for the job market to make sense is to make jobs valuable again (read more scarce). Right now they are a dime a dozen. When it becomes much harder to secure a good job, the people seeking them will do what they always have done; brush up on their knowledge, their willingness to learn, their appreciation for hard, and or, smart work, and a healthy respect for their employer’s position in the equation. The biggest lever the Fed has is to “correct” the housing market, which will then affect jobs, reversing the wage-price spiral. Things like egg prices dropping precipitously sound like inflation is being tamed, but enough items can’t drop fast enough to offest sticky higher wages. Unless one of the items is the market value of the houses of the egg buyers.
Did higher labor costs justify PepsiCo raising price by 15% in Q4 and another 15% in Q1? And is shrinking the economy the best and only approach to quelling inflation?
Like most other companies, Pepsi raised prices as much as they thought they could get away with, as fast as they could. They think in terms of quarters because that’s how their shareholders want them to think.
“Get it while you can”
And there’s nothing wrong with that. At some point, their labor and some raw material costs will come down, and their pricing won’t.
Margins will improve and shareholders will be rewarded again.
So, think about all the companies in so many industries, doing the same as Pepsi and acting in their best self interest. Not able to keep a lid on labor costs they actually become complicit in propelling them upward along with competitors and other industries as a matter of survival.
Only the Fed can stop the upward spiral. And I think a downward spiral is what it still takes when inflation gets out of control. It certainly is debatable whether it is “best”
depending on whether one keeps, or loses a job I guess.