Markets and the people who trade them (that could be a soap opera: “Last time, on ‘Markets and the People Who Trade Them”…) appeared pretty sanguine ahead of the latest inflation update out of the world’s largest economy.
It wasn’t so long ago when equities were 5% off the highs (jump off a bridge, I know) and traders were perilously close (~5bps) to pricing even one 2024 Fed rate cut as something other than a sure thing.
But that was then. This is now. And the selloff was canceled for lack of interest. Everyone suddenly remembered that all of this stuff is completely beholden to us by virtue of being a figment of our imagination: If we wanted vol to recede and stocks to rise, all we had to do was sell vol and buy stocks! Problem solved.
So here we are in mid-May and all seemed generally well in our burning world with US CPI due. Global equities were at new record highs, for example.
MSCI’s gauge was gunning for a fifth straight session of gains, the longest in months and a ninth up day in 10.
We can get into all the nuance you like, but suffice to say stocks aren’t interested in the bear case. Any bear case. What matters is that the Fed isn’t likely to hike again (Jerome Powell reiterated as much earlier this week), the ECB’s ready to cut and the BoE might be too.
The AI narrative escaped US reporting season intact. Nvidia’s earnings, due later this month, have “make or break” potential we’re told. But we’ve been told that about any number of releases and reports, including Wednesday’s US CPI update, which Bloomberg billed as “perhaps the most important release for markets this year.” (It’s the most important release since the last one, and until the next one.)
Notably (not really, but I pretend this stuff matters because you think it does and I’m writing for you) fund managers were incrementally more optimistic on rate cuts and inflation this month versus April.
As the figure above, from the May vintage of BofA’s Global Fund Manager survey (summarized here), shows, 83% of panelists expect lower short rates in 12 months and 69% expect lower inflation. Those shares are up from April. Optimism around lower rates and inflation had faded a bit off the dovish extremes amid successive US CPI overshoots.
Still, fund managers consider inflation to be the biggest tail risk. And by a wide margin. 41% picked inflation over armageddon this month. Most geopolitical risks have no readily identifiable transmission mechanism to corporate bottom lines, nor monetary policy, and the big geopolitical risks (e.g., nuclear war) can’t be hedged. Of course, the current geopolitical landscape is inflationary, and thereby has ramifications for monetary policy, which means a survey that treats inflation and geopolitics as separate choices is a poorly-designed survey but… see! I told you it wasn’t notable.
Generally speaking (i.e., outside of the current context), it doesn’t make sense for investors to trouble themselves with geopolitics. But inflation — now that’s a risk to fund managers! Not because it matters for them personally, being rich and all. But rather because it matters for discount rates and thereby for the equities people who never read a Jack Bogle book pay fund managers to buy on their behalf.
As the figure above shows, hard landing retained the third spot with 15% share, while Donald Trump narrowly beat out systemic credit event for fourth. I’d gently note that those two categories could be rolled into one: Trump’s a living, breathing “systemic credit event.”
I alluded to this above, but let me just drive home the point: The “biggest tail risk” chart is for all intents and purposes useless. For one thing, there’s always considerable overlap between the risks (e.g., Why is geopolitics a tail risk? Is it just a generalized sense of angst at the fraught state of international relations? Or is it the read-through for inflation? If the latter, why not just choose inflation?). For another, there’s something silly about suggesting we can preemptively identify tail risks and also rank them. A defining feature of tail risks is that they tend to be difficult to identify ahead of time, let alone arrange, rank and order. And then there’s the small matter of: Who cares? Who cares what fund managers think? How many of the 245 participants in the May survey have some plausible claim on being able to beat the S&P 500 over long investment horizons? I can answer that: None of them. None of them have such a claim, because I can count the people who can make that claim on one hand and to my knowledge, none of them are represented in this poll.
Anyway, the stocks are at (or near) records. The central banks are either inclined to cut (the ECB and the BoE) or else not likely to hike again regardless of whether inflation recedes to target anytime soon (the Fed). And markets are generally sanguine, like the people who trade them.
The k-shaped economy is alive and well.
Exhibit 1 (for the lower half of the K) is the pending Red Lobster bankruptcy filing due to its “All-you -can-eat shrimp promotion” that led to an $11M loss in Q3 last year and due to lower foot traffic. Landlords be prepared for incoming lease renegotiations!
Exhibit 2 (for the upper half of the K) just go out to any nice restaurant and try to get a table at 6:30pm without a reservation for 3, even on a Tuesday night. It isn’t a “sure thing” that you will get a table.
Identifying and evaluating tail risks is an important part of what makes a market function. The nature of a hedge is to reduce the probability of the event transpiring in the worst possible form. That goes for active hedges as well as those planned actions. Thus evaluating and hedging reduces the overall severity of the risk, benefitting all. I am sure you know this but I think the point is important enough that some color should be added.
Jesus Christ, Dan. This is supposed to be a lament for the inherent pointlessness of everything we do every day as human beings. Read between the lines. You’re over here reading me the first paragraph of a training manual for new traders. You forgot this: “Also, the bathrooms are just down the hall to the left. If you’re going to do coke in there, be courteous: Don’t leave your dirty straws on the counter.”
That’s very courteous of you to not leave your dirty straws. I also appreciate you writing about things that bore you and adding that wonderful flare of “i don’t give a f***”.
Finally! Someone who participated in the survey!
(I didn’t realize the market was functioning….)
I think of the “tail risk” survey as a sign of positioning. Investors being more prepared for the #1 tail risk (inflation), if that risk manifests they may not react as violently, while if the #6 tail risk (AI bubble) manifests, more investors will be unprepared and scrambling. In that sense, the #1 tail risk is less of a risk than #6. Or something like that.
That makes sense, sir. Speculators and the few remaining real investors out there have become 110% obsessed with the dot plots and Fed policy in general so they are well-attuned to various inflation narratives.
Gotta say the low percentage of concern over election risk surprises me.
The lack of concern about Trump being elected is indeed surprising. But I guess it’s like learning that a meteor is going to swing by Earth and may or may not hit it. All you can do is ignore it.
Not everyone is blissfully ignoring the meteor:
https://www.marketwatch.com/story/ray-dalio-believes-theres-a-35-40-chance-of-a-civil-war-in-the-u-s-and-would-vote-taylor-swift-for-president-736f5653?mod=mw_more_headlines
Not that surprising considering the population surveyed.
The S&P 500 was up 0.3% on January 6.
Your logic is correct, IMO, but the other half of the analysis is to multiply the perceived odds of the risk (45% for inflation) by the cost of its occurrence. My suspicion is that although the AI risk is perceived as lower, the cost is likely to be much higher, justifying your sense of the situation.
“Roaring Kitty” should’ve been a philosopher instead of a day trader. He understands that all of this — stocks, companies, etc. — are things we made up, and are thus completely beholden to our whims. Stocks trade where we decide they trade. Risks (“tail” or otherwise) are only relevant if we decide they are. A left-for-dead physical video game reseller with virtually no sales can be the most valuable company in the world if we want it to be.
Back in the day when market makers reigned supreme in what would later become the NASDAQ, my number one mentor would come to work on Mondays and everyone on the faculty would be asking him about his best idea for the week. He always had one, complete with a very plausible elevator pitch. The previous week he would have bought a few thousand shares of this tiny baby and by Monday he had a killer position and would start selling his theory. Friday, after a nice rise in price he would sell his position and bank the cash. In those days 300-500 shares would move the market so ten or 15 of his colleagues could easily push the market up 5% or more. Rinse and repeat. He and Roaring KItty were probably related. I loved to watch it. Unfortunately, I had no money in those days so I couldn’t do much about these opportunities. I also didn’t know which stock until that magic Monday.