"Did I miss it?"

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April 27, 2020
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Markets are in the ‘Did I miss it’? phase, wondering if the rally from the end March lows will now be followed by a long period of consolidation or a return to previous lows. As such many are searching for negative news, hoping to get back in lower down. The question, as always, is who would be forced to sell at lower levels than here. And why? We know from last week that some (likely amateur) traders in the Oil markets were very much forced sellers, but from here it is difficult to see who else may be. Likely we will see some selling rallies rather than buying dips continue for a while, but for too many long- term investors where else do they go? Rather like anyone planning a summer holiday in fact.

As ever, the talking head economists are doing their best to be gloomy, and undoubtedly the data at the moment helps. One of the mildly positive things about the whole Covid episode is that it will put an end to the nonsense talked about the post 2008 period being “The Great Recession”, when it was just a temporary downturn triggered by a working capital crisis. Sure, statistically the numbers went all over the place for a few quarters, but that was mostly down to the movements in inventories and the way in which they can heavily distort the GDP data. Post the GFC, companies with no access to bank liquidity ran down inventories and stopped production of ‘new stuff’. Prices and output fell, as of course did GDP. Equally once those inventories stopped being run down (as they had been depleted), they stopped being a drag on the GDP calculation and prices also stopped being at the ‘fire sale’ level. Then, in spring 2009 when normal levels of demand started to return, Industrial Production started up and we had the ‘surprise’ V shaped recovery.

Thus just as March was to February 2020 as October was to September 2008, the month in which the market mechanics dominated as distressed selling and margin calls created a liquidity crisis in markets, so April has similarities to November and December 2008, when what Nigel Lawson once referred to as ‘teenage scribblers’ popped up everywhere to lament the awful state of the world and, by the way, please buy the overpriced bonds/currency/gold I am selling. The subsequent equity bull market was known as one of the most bad tempered in history as so many professionals got out at the bottom and never got back in again.

The market currently, as then, is simply rebounding from a heavily oversold position, but the pundits, having got very excitable around the lows are now doubling down on their gloom, encouraged by those who want bonds (even) higher or a chance to buy equities lower. The latest excitement is about the flash PMI data, one of the more popular high frequency data items beloved by the rolling news services, along with the NonFarm Payrolls. While the latter suffers from the existential problem in that its central premise (that the Fed follows an output gap model to set interest rates) has failed to operate in real life at any time in the last decade, the former is mis-used on a regular basis by High Frequency Analysts /economists (HFEs) who use it to claim insight into economic conditions. Given that these people are invariably employed in Bond Markets, it is only the ‘bad’ numbers that attract attention and allow the HFEs to claim wisdom for themselves and their markets and ignorance for those in equities.

The fact that the PMIs tell us nothing that management hasn’t already told stock analysts is ignored of course, but perhaps the bigger sin is that so many of the HFEs and the market commentators who follow them don’t even understand what a PMI actually is. Put simply, it is a confidence measure. Purchasing managers are surveyed as to whether things are better or worse than last month, the negatives are subtracted from the positives and the whole lot is rebased at 50 as neutral. This diffusion index thus has two important caveats – first, if the economy is growing at 9% but managers think next month it will slow to 8%, then the PMI will be negative. This has happened on more than one occasion in the US (albeit at lower numbers) and on multiple occasions in China. In mathematical terms it measures the second derivative, the rate of change in the rate of change (growth). This is absolutely not the same as saying that a PMI below 50 means a recession. The fact that when recessions occur the PMI is often below 50 is to confuse correlation and causality.

The ignorance about the PMI, whether wilful  or not, was behind much of the pre Covid predictions of collapse in China that never came to pass and it is perhaps worth reminding ourselves of one of the other great ‘mis-understandings’ about the United States’ great rival; that it is not, indeed is far more than, an emerging market dependent on US consumers. Such has been the rhetoric over ‘the Chinese virus’ in recent months as part of an escalation of the New Cold War, that many appear to have forgotten the fact that ‘Made in China 2025’, the catalyst for the New Cold War effort, is all about moving further up the value chain and that far from being worried about a drop in US imports of cheap clothing and footwear, China has already outsourced to Vietnam, Bangladesh and elsewhere on the New Silk Road. The same with all the (resumed) rhetoric about ghost cities and over-investment. That was in 2010/11. China is now about servicing its internal consumer market.

Tesla’s Shanghai venture is an interesting example of this thinking. Tesla Shanghai is ring fenced from the rest of Tesla and is effectively operating in a ‘free factory’. However, it is dependent on China and Chinese banks for its capital and working capital and it will be liable for Chinese taxes. Its production will be for internal consumption. This is not like Foxcom and Apple, where all the value added is transferred to California, China has effectively got Tesla’s brand in exchange for that free factory. It doesn’t need to steal the IP, it just has a JV. Moreover, the components are also to be sourced in China. As noted previously, with almost half of all transportation fuel in China being used in haulage, the Tesla truck will be of huge interest to the Chinese government, which is interested both in reducing pollution (particulates not CO2) and in reducing its vulnerability to imported fuels.

To that end, the collapse in the Oil price, (beyond the short term machinations of the May futures delivery debacle) is a huge positive for China and emerging markets generally, if, like China, they have the balance sheets to plan ahead and build reserves. On the flip side, it is bad news for Saudi Arabia, as even when the price gets back into equilibrium it will likely be at a level below that which allows the current Budget deficit to be manageable.  The other largest producer, US Shale, looks likely to become part of ‘big oil’, albeit backed by the US taxpayer.

Meanwhile, one final musing for a Monday. We know that the final stages of the blow-out in the May Oil contract was likely to have been amateur traders, but it is still a fact that a lot of ‘professional’ traders would have effectively written puts at around the $50 a barrel level at the start of the quarter. Somebody somewhere has a very big 2008 sized hole in their balance sheet…

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Political Cicadas - no change in the product, just the sales team

The habit of spending long periods underground before re-emerging is not limited to the Cicada, for while this year sees the coincidence of the 13 year year Cicada cycle and the 17 year one, something that last happened 221 years ago, it is also 17 years sine Tony Blair was last in power and 13 since Francois Holland (likely PM in the French Hung Parliament) was. Both now look to be re-emerging to ensure continuity of policies that never really went away. The key sources of protest across Europe - crippling expensive wars against Russia and Climate change as well as uncontrolled immigration have only been addressed in the doubling down - the first thing UK PM Starmer did was fly to Washington to offer more money to NATO, while his Chancellor promised more money for Net Zero. Meanwhile, the left alliance put together to thwart Le Pen is even more pro immigrant than Macron. For markets, there is no prospect of lower spending and every prospect of higher taxes - the only 'Change' visible but not the one promised. The Technocrats and Globalists expecting this 'democracy' means that the populous will go quietly will be disappointed, especially with the arrival in the Autumn (once the Cicadas have gone) of the great populist, anti open border, anti net zero and anti war populist Donald Trump.

Market Thinking July 2024

The scorecard for the first half puts Equities, commodities and Gold in the top half of the table, with cash and fixed income in the lower half. This is consistent with the steady but uninspiring macro backdrop and positioning ahead of a tricky H2 from a political perspective. The anomaly of the Market Cap weighted SPX out-performing the equal weighted SPW by over 10% points tells us both that the SPX is no longer telling us anything about the US economy and that this excess return is for taking (considerable) concentration risk. Meanwhile, with Bond analysts 'pivoting from the Pivot' the fixed income markets have calmed down a little and leaving The Donald' rather thna 'The Fed' as likely the biggest policy influence on Markets over the next 12 months. In particular, we would look out for a 'Trump Plaza Acord" early next year, 40 years after the last one- something the FX markets aren't talking about, but the asset allocators seem to be (at least subconsciously) pricing in.

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