Men, it has been well said, think in herds;
it will be seen that they go mad in herds,
while they only recover their senses slowly,
and one by one.
~ Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (1852)
Fed way too slow, way too late | Wolf Richter
“This most reckless Fed ever has had some kind of come-to-Jesus-moment late last year when it did acknowledge the problem it had set off. And now it’s trying to act way too slowly, way too late, and way too timidly to break up this spiral without causing the whole house of cards – the magnificent asset bubbles everywhere – that its money-printing and interest-rate repression created to come crashing down all at once.”
~ Wolf Richter, Wolfstreet
No soft landing
10-Year Treasury yields have climbed in response to the December FOMC minutes which suggest a faster taper of QE purchases and faster rate hikes. Breakout above 1.75% would offer a medium-term target of 2.3% (projecting the trough of 1.2% above resistance at 1.75%).
The Dollar Index retreated below short-term support at 96, warning of a correction despite rising LT yields.
Do the latest FOMC minutes mean that the Fed is serious about fighting inflation? The short answer: NO. If they were serious, they would not taper but halt Treasury and MBS purchases. Instead of discussing rate hikes later in the year, they would hike rates now. The Fed are trying to slow the economy by talking rather than doing — and will be largely ignored until they slam on the brakes.
Average hourly earnings growth — 5.8% for the 2021 calendar year — is likely to remain high.
A widening labor shortage — with job openings exceeding total unemployment by more than 4 million — is likely to drive wages even higher, eating into profit margins.
The S&P 500 continues to climb without any significant corrections over the past 18 months.
Rising earnings have lowered the expected December 2020 PE ratio (of highest trailing earnings) for the S&P 500 to a still-high 24.56.
But wide profit margins from supply chain shortages are unsustainable in the long-term and are likely to reverse, creating a headwind for stocks.
Warren Buffett’s long-term indicator of market value avoids fluctuating profit margins by comparing market cap to GDP as a surrogate for LT earnings. The ratio is at an extreme 2.7 (Q3 2020), having doubled since the Fed stated to expand its balance sheet (QE) after the 2008 global financial crisis.
Stock prices only adjust to fundamental values in the long-term. In the short-term, prices are driven by ebbs and flows of liquidity.
We are still witnessing a spectacular rise in the M2 money stock in relation to GDP, caused by Fed QE. The rise is only likely to halt when the taper ends in March 2022 — but there is no date yet set for quantitative tightening (QT) which would reverse the flow.
Gold continues to range between $1725 and $1830 per ounce with no sign of a breakout.
Conclusion
Expect a turbulent year ahead, driven by the pandemic, geopolitics, and Fed monetary policy. Rising inflation continues to be a major threat and we maintain our overweight positions in Gold and defensive stocks. A soft landing is unlikely — the Fed could easily lose control — and we are underweight highly-priced growth stocks and cyclicals, while avoiding bonds completely.
Never waste a good crisis
The Russian Federation has amassed a large army on the border of Ukraine and threatens to invade unless the US and NATO make concessions including the withdrawal of forces from Eastern Europe, securing Moscow a broad sphere of influence. There has been much hand-wringing in Western media: will Putin invade or is this just a ruse designed to extract concessions?
If we look past the uncertainty, it is clear that an increasingly over-confident Putin has entered a trap of his own making.
The West is faced with an ultimatum: either concede or Russian forces will invade Ukraine.
But every problem presents an opportunity.
The more aggressive Russia becomes, the stronger NATO gets.
Russian actions have united Western alliances, with even long-term neutrals Finland and Sweden, moving closer to NATO. Both Finnish and Swedish presidents reiterated their right to join NATO in response to the Russian ultimatum.
Germany has long obstructed a stiffening of NATO defenses, increasing its vulnerability to Russian energy blackmail by shuttering nuclear power plants and supporting the Nordstream 2 gas pipeline across the Baltic Sea. But opposition is growing. A recent poll shows that the percentage of Germans who trust Russia has fallen by 11% over the past two years:
Concessions are unlikely, simply because there is nothing to gain from them. Concessions by the US would weaken NATO and encourage the Kremlin to make even more outlandish demands in the future. Concessions by NATO without the US would produce a similar outcome.
Russian invasion of Ukraine would be a strategic mistake.
First, invasion would be a flagrant act of war, removing the cloak of deniability that has covered Russian operations in the Donbas region. A formal state of war would increase the flow of Western technology and weapons into Ukraine as Western leaders are required to openly acknowledge Russian aggression.
Land invasions are costly in terms of both blood and treasure. The Russian army may eventually overrun the Ukrainians through the weight of forces and technological advantages. But Ukrainian armed forces have been in a protracted war in the East and are well-trained and equipped with modern anti-tank weapons, artillery and unmanned drones. The costs would be high.
Turkey’s Bayraktar Unmanned Armed Combat Drone – Source: Ukrinform
Where the Ukrainians are at a disadvantage is in air defenses and vulnerability to long-range missile attacks. But that window is closing.
To stiffen Ukraine’s ability to resist, the United States and NATO have dispatched teams in recent weeks to survey air defenses, logistics, communications and other essentials. The United States likely has also bolstered Ukraine’s defenses against Russian cyberattacks and electronic warfare. (David Ignatius, Washington Post)
An air campaign would also achieve little without a follow-up land invasion.
Even if the Ukrainian forces are defeated, that is where the real problem starts. Occupation is a costly and morale-sapping exercise as the Soviets discovered in Afghanistan in the 1980s and the US discovered in Vietnam, Iraq and Afghanistan (they’re slow learners). An insurgency negates the occupiers’ advantages in air power and technology, leading to a drawn-out campaign with no outcome.
“You have the watches. We have the time.” ~ Taliban fighters in Afghanistan.
A Russian occupation force would require 20 combatants for every 1,000 Ukrainians, according to a formula devised by Rand Corp. analyst James Quinlivan in 1995. That would translate into an a required Russian force of almost 900,000, illustrating the impracticality.
We could expect a Russian occupation to be exceedingly brutal, along the lines of Syria, creating a humanitarian crisis and flooding the West with refugees. But that is only likely to harden resolve, marginalizing appeasers in the West, and increase support for the insurgents.
The cost of an extended Russian campaign would deplete the Russian Treasury, even without increased sanctions. It would also escalate opposition within Russia, spurred by the high cost in lives and deteriorating living conditions. The result would threaten collapse of the Russian state in much the same way as the campaign in Afghanistan led to the eventual disintegration of the Soviet Union.
Conclusion
The threat of armed invasion of Ukraine is a mistake. It is likely to strengthen resolve in the West and, if the threat is carried out, result in a long, protracted war in Ukraine. The cost in both blood and treasure would threaten to topple the Russian state.
Russian overconfidence has led them into a trap. Thinly spread across a number of conflict zones, they are vulnerable to an escalation in insurgencies wherever they have “peace-keeping” occupation forces: Syria, Belarus, Ukraine, Moldova, Georgia, and now Kazakhstan. The cost to the West would be low but would exact a huge toll on the Kremlin, depleting their military and already-vulnerable financial resources.
“Moderation in the pursuit of liberty is no virtue.”
~ Charlie Wilson’s War: The Extraordinary Story of How the Wildest Man in Congress and a Rogue CIA Agent Changed History
S&P 500: Small caps diverge
The S&P 500 ($INX) remains bullish, with Trend Index holding above zero for over a year indicating tremendous buying pressure.
Narrow breadth is our main concern, with the Russell 2000 small caps ETF (IWM) diverging from the S&P 500 ($INX).
Conclusion
The market is growing risk-averse as the Fed starts to taper. But financial markets are still awash with cash.
Buying is likely to be concentrated in the heavyweights.
Small caps could possibly accelerate into a down-trend but reversal of large cap indices is unlikely with so much liquidity.
Omicron may be our best hope of taming the pandemic
Almost a year before Omicron appeared, Paul Ewald, an evolutionary biologist, predicted that the COVID virus would evolve in the direction of a highly contagious but less deadly variant.
Omicron is certainly proving more contagious than earlier variants.
Source: Bloomberg
But the hospitalization rate — for those above 30 years of age at least — is far lower than the earlier Delta variant.
Source: Bloomberg
The higher rate of hospitalizations among children under 9 may not be as concerning as it first seems:
Professor Mignon McCulloch, who is the Chairperson of the SA Paediatric Association, has urged people not to panic during her appearance on CapeTalk. Around 20% of new admissions for COVID-19 in Tshwane have been in children aged nine or under, whereas similar spikes have not been seen in any other age groups.
However, it doesn’t mean that Omicron is more dangerous, or even more deadly for children. According to McCulloch, it’s very likely that the children admitted to hospital are actually there for reasons other than the virus – and it is ‘coincidental’ that they have also tested positive for COVID-19 when checked by hospital staff. (The South African)
Evolutionary path
Earlier, researchers at the University of Exeter found that the most virulent variants of a pathogen may transmit the fastest, but tend to lose out in evolutionary terms to less virulent strains:
Pathogens have a single evolutionary goal – to produce more of themselves. “Virulence will evolve towards a level that optimizes their ability to transmit,” Dr Bonneaud said.
If the pathogen meets resistance to transmission — in the form of a recovered and immune or vaccinated host, or social distancing — then highly virulent forms die out with their host, and natural selection favors less virulent forms.
If there is no such resistance, the pathogen can kill its existing host at no evolutionary cost and will remain highly virulent…..
Paul Ewald, at the University of Louisville in Kentucky, said humanity had drawn a short straw with Sars-CoV-2 because it was both highly virulent and highly transmissible when it emerged.
Over time it is likely to reduce its virulence – in fact, that may already be happening, as reflected in falling mortality rates.
“I would expect it to evolve to a virulence that is very much like [seasonal] influenza,” Prof Ewald said in November last year.
“And containment measures, properly implemented, should accelerate that process.” (The Guardian)
Host mobility
Paul Ewald’s research focuses on the dependence of disease organisms on the mobility of their host for transmission. A patient (host) who is bed-ridden or dies is less likely to transmit the infection — unless the disease has another means of spreading other than personal contact/close proximity. A host with mild symptoms is far more likely to move around in the community and spread the disease.
If a disease organism is very dependent on healthy hosts moving around [and] contacting susceptible hosts, then we expect natural selection to favor extreme mildness in those disease organisms. If, however, the disease organism is not dependent on host mobility — for example, if the disease organism is transmitted by mosquito, or contaminated water, or because it’s durable in the external environment — then we expect that natural selection will favor high levels of harmfulness in those disease organisms…..
When we look at the population of disease organisms in any given area, we see both mild and harmful strains….. all we need to do is tip the competitive balance in favor of those mild strains.
We can look at the experience in South America and Central America as a kind of a natural experiment that allows us to evaluate these ideas. In 1991, cholera came into Peru and then quickly, within a couple of years, spread all throughout South and Central America. Some countries had clean water supplies, and other countries had contaminated water supplies. What we find is that when the organism invaded countries with clean water supplies, the organism dropped in its harmfulness.
In contrast, the organisms that invaded countries with poor water supplies — countries like Ecuador — evolved increased harmfulness over time. They’ve actually become more toxigenic. (Paul Ewald: Infectious Disease and the Evolution of Virulence)
Conclusion
We can use evolution to encourage diseases to evolve into milder forms that are not as harmful and also create resistance to more virulent strains. Use of vaccines, handwashing, masks and social distancing help to restrict more virulent forms of the virus and encourage milder versions like Omicron to take over, developing herd immunity.
Opening up populations to a pandemic — in the misguided hope of creating herd immunity — are likely to have the opposite effect. Unhindered transmission would encourage evolution of more virulent strains, with far higher hospitalization and death rates.
Acknowledgement
Hat tip to Macrobusiness for the images
Doug Kass | 50 laws of investing
Doug Kass wrote these 50 laws, incorporating many of Bob Farrell’s 10 rules, in an article in Barron’s. Doug is founder and president of Seabreeze Partners, with more than 45 years experience in financial markets.
- Common sense is not so common.
- Greed often overcomes common sense.
- Greed kills.
- Fear and greed are stronger than long-term resolve.
- There is no vaccine for being over-leveraged.
- When you combine ignorance and leverage – you usually get some pretty scary results.
- Operate only in your area of competence.
- There is always more than one cockroach.
- Stocks have a gravitational pull higher – over long periods of time equities will rise in value.
- Long investing generates wealth.
- Short selling protects wealth.
- Be patient and learn how to sit on your hands.
- Try to get a little smarter every day and read as much as humanly possible – an investment in knowledge pays the best dividends.
- Investors sometimes think too little and calculate too much.
- Read and re-read Security Analysis (1934) by Graham and Dodd – it is the most important book on investing ever published.
- History is a great teacher.
- History rhymes.
- What we have learned from history is that we haven’t learned from history.
- Investment wisdom is always 20/20 when viewed in the rearview mirror.
- Avoid “first-level thinking” and embrace “second-level thinking.”
- Think for yourself – those who can make you believe absurdities can make you commit atrocities.
- In investing, that what is comfortable – especially at the beginning – is most often not exceedingly profitable at the end.
- Avoid the odor of “group stink” – mimicking the herd and the crowd’s folly invite mediocrity.
- The more often a stupidity is repeated, the more it gets the appearance of wisdom.
- Always have more questions than answers.
- To be a successful investor you must have accounting/finance knowledge, you must work hard and you have to be keenly competitive.
- The stock market is filled with individuals who know the price of everything but the value of nothing.
- Directional call buying, when consumed as a steady appetite, is a “mug’s game” and is often a path to the poorhouse.
- Never buy the stock of a company whose CEO wears more jewelry than your mother, wife, girlfriend or sister.
- Avoid “the noise.”
- Reversion to the mean is a strong market influence.
- On markets and individual equities… when you reach “station success,” get off!
- Low stock prices are the ally of the rational buyer – high stock prices are the enemy of the rational buyer.
- Being right or wrong is not as important as how much you make when you are right and how much you lose when you are wrong.
- Too much of a good thing can be wonderful – look for compelling ideas and when you have conviction go ahead and overweight “bigly.”
- New paradigms are a rare occurrence.
- Pride goes before a fall.
- Consider opposing investment views and cultivate curiosity.
- Maintain a healthy level of skepticism as you never know when the Cossacks might be approaching.
- Though doubt is uncomfortable, certainty is ridiculous and sometimes dangerous.
- When investing and trading, never let your mind dwell on personal problems and always control your emotions.
- ‘Rate of change’ is the most important statistic in investing.
- In evaluating the attractiveness of a company always consider upside reward vs. downside risk and ‘margin of safety.’
- Don’t stray from your investing and trading methodologies and timeframes.
- “Know” what you own.
- Immediately sell a stock on the announcement or discovery of an accounting irregularity.
- Always follow the cash (flow).
- When new ways of earnings are developed – like EBITDA (and before stock-based compensation) – substitute them with the word… “bullshit.”
Two Bonus Rules
- Favor pouring over balance sheets and income statements rather than spending time on Twitter and/or wallstreetbets.
- Always pay attention to what David Tepper and Stanley Druckenmiller are thinking/doing. (Trade/invest against them at your own risk).
Bob Farrell | 10 rules for investing
Bob Farrell wrote these 10 rules after spending more than 50 years on Wall Street. He is dead today but his rules still apply, even in the current bull market euphoria.
- Markets tend to return to the mean over time.
- Excesses in one direction will lead to an excess in the other direction
- There are no new eras — excesses are never permanent
- Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
- The public buys the most at the top and the least at the bottom
- Fear and greed are stronger than long-term resolve
- Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
- Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
- When all the experts and forecasts agree — something else is going to happen
- Bull markets are more fun than bear markets
Hat tip to Lance Roberts at Real Investment Advice.
Services inflation
A friend asked a question: “Our advanced economies are 70 – 80 % Services based these days; so will this make CPI inflation difficult to sustain if wages growth is not sustained.”
The answer is YES. Inflation is unlikely to be sustained if wages growth declines.
BUT wages growth is accelerating, not declining, both in the services sector and in the broader economy.
Wages growth is also not likely to decline while we have record job openings; 5.4 million in the services sector alone.
Employers are having to offer higher wages and sign-on bonuses to attract workers — the result of record high savings levels fueled by government stimulus.
New COVID variant upsets markets
JOHANNESBURG — A new coronavirus variant has been detected in South Africa that scientists say is a concern because of its high number of mutations and rapid spread among young people, Health Minister Joe Phaahla announced Thursday.
South Africa has seen a dramatic rise in new infections, Phaahla said at an online press briefing.
“Over the last four or five days, there has been more of an exponential rise,” he said, adding that the new variant appears to be driving the spike in cases. (NBC)
Concern is focused on the rapid spread of new cases and the variant’s high number of mutations which could make the virus resistant to current vaccines.
The new COVID-19 variant, called B.1.1.529, has a very unusual constellation of mutations, which are worrying because they could help it evade the body’s immune response and make it more transmissible, scientists have said. South African scientists have detected more than 30 mutations to the spike protein, the part of the virus that helps to create an entry point for the coronavirus to infect human cells…..In comparison, the Beta and Delta variant respectively have three and two mutations. (Al Jazeera)
The UK suspended flights from 6 African countries on Thursday. (Yahoo.com)
The S&P 500 fell 2.3% on Friday, while declining peaks on the daily Trend Index warn of a correction.
Conclusion
There is a high level of uncertainty as scientists do not yet know how lethal — and how resistant to vaccines — the new strain is. Investors are being cautious and reducing risk. Expect a correction to test primary support but no bear market unless worst fears are realized.