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Markets May Become Increasingly “Messy”

 

 

“Davidson” submits:

At any point in time, markets are messy. The current environment is particularly messy with Russia and China seeking to take advantage while the rest of the world is focused on the nasty politics playing out in the US. The US, the historic guarantor of Democracy globally, appears deep in the throws of self-doubt. Confusion is the tool of those seeking to exert greater political and economic control. The phrase “Never let a good crisis go to waste” is well known. Everyone has a personal agenda or a ‘sales pitch’ with truth of any situation buried in noise. Manipulative activity at a high pitch dominates social and major news media. That this makes one’s head spin is an understatement.

 

The themes currently:

 

  • COVID lockdown/vaccinations or reopening-to mask or not to mask?
  • Economic correction or reopening?
  • What is government policy and what is the net impact?
  • Are rates rising or falling?
  • Is oil rising or falling?
  • Is inflation temporary or not?
  • Is there and will there be Global Warming/Green New Deal or not?
  • Should government control of innovation and climate actions or not?
  • Is Russia/China on the verge of another maneuver for power, wealth and global control?
  • How much does computer algorithms/inexperienced investors trading on price-trends distort market psychology?
  • Is Bitcoin is the new ‘gold’, the new ‘global currency’ or not?
  • Add to this list at your leisure, so many to choose from…

 

Each has its own narrative. Each narrative carries its own market psychology which ebbs and flows sometimes in sync and then out of sync with the others with periods of being additive and alternating periods of cancellation complicated by how much importance  investors attribute to each at any point in time. In the last 10days, Russia suddenly comes to the fore as on the verge of invading Ukraine. https://www.wsj.com/articles/russia-biden-next-foreign-policy-test-ukraine-border-crimea-11636057131 If Russia invades Ukraine, will China then advance on Taiwan? In 2014, the Erdogan of Turkey, Xi of  China and Putin of Russia each moved to advance their autocracies driving global capital to Western markets seeking safe havens. The same is occurring today. The narrative here is a rising US$, rates falling and pricey real estate as EmgMkt capital invests for preservation of capital in currencies not their own. This can be seen as currency exchange rates respond to geopolitics followed by price shifts of sovereign debt and real estate. To weave this narrative one must pay attention to the numerous local reports over the years of money flooding into various Western real estate markets from large to small cities coupled with the timing of sovereign debt rates falling below zero and connecting the dots with geopolitics. This is EmgMkt capital with a focus more on preservation of capital than a return on capital. It is capital with less equity experience in Western markets which takes years to develop. It should be no surprise that one foreign investor who made many millions on Bitcoin turned around and paid $69mill for NFT artwork and believed it ‘cheap’. https://www.theverge.com/2021/3/11/22325054/beeple-christies-nft-sale-cost-everydays-69-million Experienced Value Investors see ‘Tulip Mania’.

 

The argument is emerging that COVID lockdown was a crisis blown out of proportion. The misinformation surrounding COVID is infused with political agenda and the actual facts may take years to rise to the surface. As investors, one had to make decisions during the lockdown and now must do the same on the reopening. There is no doubt that the economy is reopening. It is how it is reopening that matters and what impact government policies are likely to have going forward. The reopening theme has been coupled to rising rates and rising oil prices. But, capital pooling in Western markets force rates lower. It is a push/pull of investor sentiments with differing cultural perceptions. In 2014, the actions of Russia, a noticeable threat today, caused the US$ to soar and elevated $WTI to plunge as algorithms traded for recession.(see Nominal US$…vs $WTI chart) The SP500 fell ~100pts but no recession. $WTI, which was at a speculative level Feb 2014, fell from $107/BBL to the low $40/BBL 12mos later. The US$ gained ~15% against global currencies including Advanced and EmgMkts. Since then, as autocrats have gained power in EmgMkts, the US$ has continued to strengthen vs EmgMkts to 30% higher than levels of 2014. This inflow represents considerable capital pushing US rates lower. Countering this is the fundamentally based Western Value investor who perceives economic growth as the COVID reopening develops. These investors are shifting capital out of debt and into equity attracted by higher returns. Added to this mix are the Momentum Investors using price-trends and trading algorithms. Lately, the presence of another type of Momentum Investor, those who have learned to play videogames, who are responsible for the price action of Gamestop(GME) and AMCEntertinment(AMC) coordinating their activity using social media platforms. They favor price-trends but have developed trading consortiums to coordinate trading activity with heavy reliance on the theme of the day and little regard to fundamentals.

The last 10days indicates a reaction to Russia’s troops massing adjacent to Ukraine. It appears new capital forced US$ higher and 10yr Treas rates lower on this news. Lower rates are one of the algorithmic triggers for economic weakness which results in selling $WTI as a portfolio hedge. Yesterday, 10yr Treas rose ~0.15(15bps). A massive reversal in my opinion. If Russia does invade Ukraine, it will not prove a surprise and the rise in rates appears to counter this fear with greater optimism of economic growth. The Russia did surprise in 2014, but the 10yr Treas/T-Bill rate spread was ~2.5% at that time. The equity market correction was short lived. The rate spread is another input for algorithms and it offset the negative signal from the rising US$ at the time. Today, the rate spread is ~1.5-1.6% and positive for higher equity prices. In my opinion, negative geopolitical events are likely to have short lived impact as long as economic trends continue to favor equities. Should China move against Taiwan, which is not a strong factor in investor consideration currently, a reassessment would be required.

The reopening theme has slowed having already regained the bulk of economic activity the past 18mos. Employment in travel and leisure venues remain less than pre-COVID levels but continue to improve. The elimination of most international travel restrictions earlier this week has yet to impact air travel even though the stories are positive. Air travel remains ~20% below historic seasonal levels. The TSA chart was reformatted to show current activity vs year ago levels with 10day trends overlaid with historical annual July peak level and Sept annual low level trends from 2012.

At any point in the economic cycle there are always multiple issues positive and negative. There are periods the positive issues dominate only to see concern arise on new threats to growth from unexpected sources. While volatility is unsettling, as long as the rate spread is above 0.2% and especially when the spread is widening, as it is currently, equity markets have a history of shaking off negatives and working higher. Reopening continues.