Apologise for the break for June and July, we were in the process of moving and markets were relatively mixed over the summer months. A reminder that the two distinctive features of the 1332 Capital newsletter are that views are communicated over different time periods (immediate, cyclical and secular) as well as tracked between newsletter publications.
Immediate
After the correction of mid-May mentioned in the prior publication, US markets have continued a steady march higher, with the S&P 500 and Nasdaq reaching all-time highs. European markets have remained bullish with their delayed reopening from Covid, while Asian markets have begun to roll over due to their early recovery from Covid and a more defensive posture in markets in general retreating from those markets. In addition, China has been extending its tightening of political conditions to reigning in of the tech sector, leading to a significant crash in tech indices and Chinese equities overall. It should be noted that equities in China are not as broadly owned as in developed markets, with much more household savings going towards residential property.
Dispersion within the S&P500 has continued to widen with large mega-cap tech stocks leading the S&P500 higher, reflecting both the decrease in speculation on reopening and high-beta names, as well as some rollover in some measures of inflation and growth, leading to a short term peak in yields. Lumber prices have fallen significantly since their highs, while inflation in things like oil has remained sticky.
Bitcoin and Etherum have had a significant bounce from their initial correction from all-time highs. Ethereum’s EIP-1559 update making the way for a future transition to proof-of-stake may have been an initial catalyst, with bullish sentiment spilling over in Bitcoin this time, rather than the other way around. Bitcoin has run into some resistance around $50,000 (previous support), but if it can break above that it may continue on its way to mirror previous bull runs of the Bitcoin halving cycle. It should be noted that that the DoJ investigation into Tether and governments in places ranging from Canada to China to the UK, do present significant risk, and any major announcements could present unexpected events, outside of the predictable fundamentals of the market.
While margin debt is at high absolute levels, Darius Dale of 42 Macro states that positioning is still quite defensive and that other leverage players such as CTAs and Hedge Funds are not necessarily at max leverage long positions, so a significant overall market correction may not be imminent, even if valuations are very high.
Cyclical
Economic models, combined with the rolling over of the extreme base effects from the Covid shutdown mean that both growth and inflation have likely peaked. However, they are both still at high absolute levels compared to recent developed market norms, so even if they are rolling over, markets may remain buoyant past the cycle peak until it is demonstrated that growth and inflation are returning to their historic recent trends.
Confirming the economic view is Cross Border Capital’s liquidity model, which also appears to be rolling over. The remaining Covid unemployment stimulus ends in September, and there may be somewhat of an air gap approaching as politicians debate the debt ceiling and upcoming infrastructure bill. The Fed has indicated that they are still aware of inflation, and have not completely embraced MMT yet, and so any additional fiscal spending may be countered by a tightening of fed police, and any withdraw of fiscal resulting in economic slowing, may lead to the Fed continuing asset purchases via QE. Biden’s approval ratings, particularly in the wake of the chaotic withdrawal from Afghanistan, means that the senate is up for contention in the 2022 mid-terms. This means that policy intervention may be relatively neutral for the medium term, and the continuation of the cycle will be determined by more fundamental factors such as corporate and household balance sheets. It remains the view of 1332 capital that this may be shorter than prior cycles due to lack of deleveraging during the sharp recession and significant government stimulus during the Covid shut down.
Secular
The recent recommendation for the reappointment of Jerome Powell as Fed chair, and lack of consensus even among democrats for increased fiscal budget deficits confirm the view that long term secular stagnation remains the most likely long term outlook. Furthermore, while the world remains on a credit-based monetary system, increased government spending and lower interest rates only increase the amount of outstanding debt further slowing both economic growth and inflation in the economy.
QE and other central bank activity have only been papering over the cracks of the broken eurodollar system, which has not been expanding credit at the same rate as it was prior to 2008 and the GFC. It is arguable that while on the surface the GFC was a housing bubble crisis, US house prices have recently come up to and even exceed their 2008 levels, meaning that those absolute levels of house prices were not necessarily unstainable. 2008 may be better described as a eurodollar crisis, brought on by peaking demographics in Europe and a temporary trough in Anglosphere countries, due to the Generation X reaching average household formation age, and being a lot smaller than the preceding Baby Boomers.
With that in mind, the peaking Millenial generation may actually sustain the status quo, providing support for the economy and asset prices particularly in the US and delaying what may be the inevitable end to the current debt super cycle as it further puts of the chance of an economic emergency that would act as the catalyst to institute a full overhaul of the financial system. Passive investment flows from Millenials may prop up equities, leading to baby Boomers remaining investing into retirement, especially with such low fixed income yields, meaning that a deflationary shock from popping of the everything bubble may be further away than expected. With all that in mind, Ark Invest’s Cathie Woods’s view that growth, particularly in the areas of digital and technology, may continue to outperform value and the industrial areas of the economy.
The bond market and Gold both seem to be confirming this, that sustained multi-year inflation is not yet on the table, and that while millennials and the green infrastructure may provide some inflationary impulses, the effects will not be long lasting.
Summary
On all time frames, the market and economy seem to be battling between opposing forces. In the short term between valuations and market positioning, in the medium term between slowing growth yet high absolute levels and long term between deflation and inflation. Whatever your investment time frame, the prudent posture may be to stay with what the market signal is telling you, while keeping an eye out for the various risks that exist within the current structure of both the market and the financial system as a whole.
