Degenerate Business School

Doubtless THE story of financial markets in 2023 has been the astonishing comeback of MegaTech. When rates went to zero during the pandemic, the explosion in Tech valuations made sense both in terms of mechanics and narrative. If discounted cash flows were governed by the 10-year rate, then companies like Apple became something like 100 year bounds. Look far enough into the future and it was hard to imagine how the likes of Apple, Amazon, Facebook and the like could fail. But then the Fed tightened, rates went parabolic and old man favorites like Exxon Mobil had a moment in the sun. Surely MegaTech couldn't flourish until the return of ZIRP! Unless of course a narrative could sweep away all talk of mundane calculations like discounted cash flow. Because Artificial Intelligence is the end of business history. Right?Meanwhile out in the wilderness, buffeted all around by the winds of winter, Crypto has secretly grown up. This week Bitcoin was de facto legitimized by the SEC as the only investment grade asset in the whole ecosystem. In a way the Bitcoin Maxis were accidentally correct. No, Bitcoin won't sweep away the nation state, but it will be offered up by legitimate Wall Street firms. Like any good revolution, it has successfully been co-opted by the establishment. 

The Ancient Greeks used to say that Phobos, the God of Fear and Panic, ruled the battlefield. We might say the same of FOMO in the realm of financial markets. Even in the face of higher rates, an overblown debate about the debt ceiling and at least the theater of quantitative tightening, speculative fervor has returned once more to the American stock market. 2021 promised a revolution in Blockchain technology, whatever that means. And now 2023 foretells the end of human intelligence for all time. AI, it is said, will solve every conceivable problem. And therefore any company attending to its rise will capture all future financial value. By now call buying on Nvidia is more fashionable than wearing Crocs to a Shawn Mendes concert. And by now we have learned that average retail investors like us are chumps if we think we can chase such a rally as this. But we must remember that all innovations, whether destined to change business history and our lives forever, must first be overrated in the short term. Before they are underrated in the long term. See the internet in 2000. 

Over the past year, the S&P is down just 4%. In the world of equity markets, that is essentially...nowhere...a nothing burger. This on the heels of the Fed's most aggressive hiking campaign in living memory, one that began last March. Doubtless there have been puzzling rallies and plunges in between, a banking crisis, the makings of a bond market catastrophe and the looming debt ceiling debacle. But in the bigger picture, how do we account for the relative strength of the equity market in the face of this uncertainty?And here we return to our favorite topic of the year, the Fed Balance Sheet. Which, you may have guessed it, has shrunk just 4% in a year. Sift through all the divination that technicals provide and the market can neither correct nor break out without the gravity wave of top down QE or QT. Suffice it to say that bulls in this market are betting on just one thing. Not better earnings, or a better economic outlook than most are projecting. There is only one question worth asking. Will the Fed be forced back into QE and when. So go asset prices. In the end, if QE infinity is the way, Tesla might be worth a laughable amount. But Chipotle will cost $100 a meal. 

We spend a considerable amount of time on our silly little podcast agonizing over levels in the S&P 500. As we hover below 4,000, is the stock market overvalued or undervalued? Did the market bottom at 3,600 in October? Will this recession bring about the same relative decline as the Tech Bubble of 2001? But it bears reminding that levels are an illusion. Pop open a chart of the equity market over the last 20 years and you can't help but think the run-up is nonsensical. How could we not be on the precipice of an epic correction? A world gone irrational! But that chart is little more than an artifact of Central Bank largesse. Over time the Federal Reserve has accumulated the liabilities of the American Financial system. The practical consequence? The inflation of asset prices to previously unimaginable heights. We are left to wonder then, what will happen to the stock market over the next decade? Far be it from me to actually say. But as Michael Howell pointed out this week, we are witnessing in real time the de facto nationalization of American Banks. The unraveling of regional banking sets in motion the next play in the same endgame. Resolved to thwart any systemic crisis, the Fed and the Treasury will absorb for all time the liabilities of the American banking sector. And they will, as ever, monetize the ever increasing Federal debt. That means only one direction for the Federal Balance Sheet. Up again. And with it, asset prices...again. 

The halcyon days of quantitative easing made us all forget one simple truth. That in the annals of financial history, bank runs are numerous and inveterate. Like the coming of spring or another movie from the Marvel Cinematic Universe. Except that the Great Financial Crisis did in practice, if not in law, change the game for all time. There are now 4 unimpeachable megabanks enameled with Too-Big-Too-Fail status and unlimited deposit insurance. And there are all the other banks, to which depositors are merely unsecured lenders. But even then, The Fed and the Treasury are clothed in immense power, and can intervene in any financial calamity if they deem it to be systemically important. Thus, in the wake of even Silicon Valley Bank's collapse, they created the Bank Term Funding Program or BTFP. Do I really know what its provisions are? Of course not. I'm on Twitter too much to know the details.But we must ask the question, is this just Quantitative Easing by another name? And in the end, do all crises lead to unlimited easing by one road or another? For there is one thing that the events of 2008 made impossible. The collapse of collateral anywhere in the West. 

We spend our days trying to guess which way financial markets will go, like medieval alchemists or broadcast news meteorologists. Is the bottom already in for the S&P and all degenerate risk assets? Where will rates go, and for how long? Is now the time to buy bonds? Does it even make sense to pick stocks?But why struggle, when staring us in the face for the first time in our investing lives, is a risk free rate of 4.4%. Plumb any mutual fund money market account from Fidelity or Blackrock and you shall find a yield of just that. Mind you taxes and inflation will still mean we're losing money, but we'll lose it more slowly. Why? Because Jerome Powell has raised the Fed Funds rate. The 1 month treasury yield is now 4.68%. Just 1 year ago, that figure was a mere 0.05%. So why not just hang out and collect? We discuss. 

With the S&P dithering in no man's land, we speculate on the implications of ChatGPT and its inevitable imitators. Needless to say it will trivialize the entire profession of data science. But will it become the greatest business-to-business software service in the history of capitalism?Next we discuss the re-emergence of short-dated options, and the potential consequences for market volatility.Lastly we wonder whether or not the zombie corpse of Bitcoin and Crypto assets writ large are breaking correlations with the Nasdaq. And if they are, does it imply institutional interest? And is that interest a hedge against the very collapse of the sovereign debt bubble? 

While the world's putative Illuminati gather in Davos, the S&P fails once more to escape its bear market structure. This in spite of some frisson over Netflix earnings and yet more bloodletting across Big Tech. Meanwhile Finance Twitter has begun to coalesce around a familiar narrative: over the next several years Emerging Market Equities will outperform the U.S. Thus we revisit one of our favorite topics. Will the emerging markets ever emerge? But this time, we turn to ChapGPT for help.And finally woebegone Bitcoin and Ethereum bounce back-ish. We discuss why, according to Alex Gurevich, if Bitcoin is Digital Gold then Ethereum is Digital Copper. 

This week with inflation cooling off and the Federal Reserve balance sheet unchanged, the S&P 500 stretched to near 4,000. But Jerome Powell has made it clear that no rally can long endure, not while unemployment hovers near 3.5%. For now the structure of this bear market remains intact. What's more we closed last week with Implied Volatility (VIX) revisiting a 52 week low. All this to say that with another week of earnings looming and a debt limit fiasco on the horizon, all signs point to more volatility in the week ahead. And just for fun, we entertain the idea of a Starlink IPO and whether or not it merits considering. 

We're back after a hiatus worthy of European aristocracy!Tesla, the last great hope of technology optimists everywhere, has at last succumbed to the Great Duration Bubble. From incomprehensible over-valuation to soul crushing underperformance, the likes of Crypto, the ARK innovation fund, Meta and now Tesla have all been deflated in their turn. And why? The Federal Reserve. Once the sponsor of the greatest financial binge in modern history, now the author of the most bloodthirsty tightening cycle in the last 50 years. But there is still a case for Elon Musk's beleaguered automaker / robotmaker. Because in the end few companies possess its engineering prowess and its formidable capabilities in Artificial Intelligence. With that in mind we asked ChatGPT to explain what drove the speculative technology bubble of 2001 (below). Swap out the word "internet" here for any of the high technology assets of the last boom-and-bust, and we have a perfect encapsulation of this moment. Needless to say ChatGPT will take our jobs sooner or later. The tech bubble of 2001, also known as the dot-com bubble, was driven by a combination of factors, including:The widespread belief that the internet was revolutionizing the way businesses operated and that investing in internet-based companies was a sure way to make money.The availability of venture capital, which enabled many start-ups to get off the ground and go public, even if they had no profits or viable business models.The abundance of "irrational exuberance," or overoptimism, about the potential for internet-based companies to generate profits.The low interest rates at the time, which made it easy for people to borrow money and invest in the stock market.The lack of regulatory oversight, which allowed many internet companies to go public with little or no financial disclosure.

The lurid collapse of FTX and with it Crytpo sentiment the world over bring to mind an old adage in high Finance. When the tide goes out, we find out who was really swimming naked. And it turns out, in the far off Bahamas, Sam Bankman-Fried was not only swimming naked. He was riding a jet ski that you paid for. What do we really mean? That in the end, the recent mania surrounding Crypto was only sustained by central bank policy. Put that much liquidity in the system, and the frontier of the risk curve, say a token like FTT, or any other crypto project with dubious innovation to recommend it, will rally. But drain liquidity, raise interest rates, crush institutional appetite, and an exchange collateralized only by the belief that Crypto was the future was bound to go bust. Say what you will about potential criminality. Bear and Lehman made the same mistake. Excessive leverage built on lofty valuations will always form dry grass for the next brushfire to carry out. In times like these, though, it is too easy to write off the whole space as trivial or deserving of its inevitable comeuppance. Every innovation is left for dead more than once. Even the internet was disparaged as little more than a cute version of the Fax machine. Until it became evident only in hindsight that it was just as consequential as the industrial revolution. In the end, it does force us to re-examine what projects actually have use cases, far off as they might seem. As ever, we discuss. 

Last week, Jerome Powell took the mic. And with the mystic language of macroeconomic policy said the equivalent of: we can't stop, won't stop, murdering your equity portfolio until inflation improves. Makes sense. The last best hope of a near term pivot died there on the podium. Practically speaking, the Fed will be hawkish throughout 2023.And so the S&P 500 lurches onward in No Man's Land at ~3,770. Who will win the day into year-end? Bulls or Bears?

Earnings season began this week with mixed results. And if there are two companies that tell the story of these times, they are Snapchat (SNAP) and Schlumberger (SLB). Snapchat you surely know. Once the darling of young people sending ephemera to each other during lockdown, it is now little more than a glorified penny stock sent reeling from its soaring pandemic-era valuation. A dreadful year for tech, social media most of all, and another dreadful earnings call to mark its passing. Schlumberger on the other hand sounds like a retail outlet for elderly European equestrians. It is in fact an Oil company. And its star is on the rise. The so-called Great Rotation, from overvalued Tech to undervalued Commodity companies, continues. Which begs a recurring question of this podcast? Are we entering the Last Great Age of Oil? A final shortage that will send commodity prices soaring and with it the profits of the fallen Oil Giants? Or will a recession wipe demand off the board? For the purposes of investing, does it even make sense to chase the rally in Oil, or has the opportunity already passed? 

This week inflation came in hot versus consensus. And while we have past the peak of so-called headline inflation, with energy costs abating somewhat, CORE inflation is still accelerating. Rent costs in particular are running wild. What does it all mean? As was, the Fed still has a data-driven license to hike rates with abandon. And in the equity markets, the price action around Thursday's print suggests traders have no conviction about the direction of travel in the S&P 500 over the medium term. They are only degenerately trading day to day moves. If we look then into the murky future, more downside feels more likely than not. Simply because there are no bullish catalysts to overcome the pall of Fed hawkishness. Patience remains the game. So with nothing to do but wait, we discuss Elon Musk's ongoing evolution into a movie character. You and I might pass the time watching TV or working out. Elon buys social platforms and tries to broker Putin-friendly peace deals. What does this portend for the future if technology entrepreneurs with unlimited wealth accrue supranational power? 

Every once in a while, we get to the point in financial markets where all that matters is...wait for it...you guessed it...BOND MARKET LIQUIDITY. In the simplest terms, there are not enough willing buyers to scoop up US treasuries. Or any government bond for that matter. Least of all, as was this week, British government debt. So dire did circumstances become in London that the Bank of England was forced to ease again and become the buyer of last resort. At the death, many pension funds were saved that otherwise would have gone out with the tide.But how did we come to this road? With the benefit of hindsight, or the foresight that very few had (like Joseph Wang), it all appears to be the work of quantitative tightening. With the Federal Reserve no longer buying treasuries with abandon, another buyer must emerge. But no such buyer exists, at least not at the margin or at least not at this scale. Tack on the global shortage of dollars needed by foreign central banks to service dollar denominated debt. And we get EPIC volatility.Some Finance Twitter experts like Lyn Alden have long argued that this dynamic is the real test for Central Banks. They might ideally like to keep tightening until inflation softens to 2%. But what might in the end trigger a pivot first is actually disorder in sovereign debt markets. The actual market that matters for all other markets. 

This week the European energy crisis took center stage on Finance Twitter. Is this right and truly checkmate for Europe? With Vladimir Putin throttling natural gas, and no longer under the pretense of scheduled maintenance, what does the winter hold for, say, German Industry?  The Germans might have enough in storage to weather the cold, but what will prices look like for European citizens and businesses?All of this has led to massively negative sentiment. Erik Townsend of Macro Voices ended his podcast this week with a prediction that the world might be ending. Well, at the very least he said the Halcyon days of cheap energy and easy living for the West are done and that World War III is at hand. Which was also his way of saying that commodities will become exorbitantly expensive over the next decade. Back in North America, we revisit the topic of Fed Policy. Sure enough, inflation and unemployment are the watchwords. But what about credit market liquidity? If that seizes up, they might be forced to waffle earlier than inflation would otherwise allow. So we turn to credit spreads. 

With the eyes of Finance Twitter fixed on Jackson Hole, Jerome Powell coolly reminded the investing public that a pivot is not in the offing. And if there is no self evident pivot, then the fever dream that was this summer's bear market rally might right and truly be over.Of course no one really knows as yet whether we're actually in a bear market or a bull market. Such is the divide in opinion around the Fed's actual willingness or ability to remain hawkish. Inflation might be the dragon of our time, in need of slaying at all costs. But is that even possible at the pinnacle of a generational debt cycle? Can the debt burden even coexist with a properly hawkish Fed. Either way, volatility looks poised to increase. But will it be a garden variety oscillation higher, or a proper capitulation and puke that sends the VIX to 40? The fabled next leg down? We discuss.

Last week, the Finance Twitter newsfeed produced an embarrassment of riches. Just to enumerate the highlights:Nancy Pelosi visited Taiwan and sent the CCP into a frenzy The jobs report blasted consensus, making way for more Fed hawkishnessAmazon bought Roomba, completing it's conquest of your homeMichael Saylor stepped down as CEO of Microstrat to work on Bitcoin full timeBlackRock announced it will now offer bitcoin trading for institutional clientsWhich of course bears not at all on the state of technicals. But it does appear that Friday's jobs report was the narrative capstone to a rally in the Nasdaq, that by all technical standards has reached very overbought levels. Is this the point of exhaustion, in the near term at least, for the counter rally?

What do we make of this rally? Is it a 2005 Donovan McNabb pump fake? That is, a bear market rally? Or the beginning of a pivot to accommodative policy once more? On Wednesday Jerome Powell said, and didn't say, just enough to prolong a run up in risk assets into the weekly close. Why?In short, he didn't say anything that was incrementally hawkish. Crack the window open for those itching to go long, and in the short-run, they will pile in and duly vaporize short sellers. As ever, we resort to charts and lines to settle the case. And in the Nasdaq, we don't yet see a decisive break above the defined down channel that has dominated this year. Best guess? Bear Market Rally. But who can say? And is there a trade worth taking in this milieu? 

This week the Consumer Price Index, the inflation measure that now governs the market, came in higher than consensus at 9.1%. And yet the 10 year treasury yield didn't move. And the equity market chopped sideways.What do we make of this? According to the high priests of the bond market, we've priced in an even more hawkish Federal Reserve in the near term. And thereby a higher chance of a recession later on. In this milieu, the long bond ETF TLT might be forming a bottom. But still the game is patience.