Who will Brunhilde be this time, so we can finally see the light at the tunnel?

Who will Brunhilde be this time, so we can finally see the light at the tunnel?

18 November 2022 from Mikael Syding

A slightly lower-than-expected inflation figure in the US made stock buyers extra eager in recent days. However, I don't think the optimism will last long. In fact, the rise may already be over. With Bitcoin at a 15 handle recently, general risk appetite doesn't exactly look super solid.

My assessment of the overall picture for the companies' profit capacity and investors' willingness to buy and financing is that it will get worse before it gets better. Right now, the market is getting ahead of itself when it hopes that "only" 7.7% Consumer Price Index CPI inflation in the US, instead of the expected 8.0%, means that you can already start counting new monetary stimulus, even though the Fed is not even done with the planned increases yet.

Most things look relatively better than a few weeks ago: the Q3 reports were perfectly OK, the job market is showing resilience even though some FANG companies have started mass layoffs, and inflation looks like it has peaked. In addition, the copper price has continued to rise since the bottom in July. At first glance, it thus looks like a kind of Goldilocks scenario is on the way, with just the right amount of growth and just the right amount of inflation and new lovely golden showers from the central banks. I think that is a serious misjudgment. Jay Powell has been very clear that the fight against inflation is a priority. The Fed will rather set interest rates too high for too long and sell bonds instead of buying them, than risk losing its grip on inflation expectations. In addition, an inflation figure is just an inflation figure. Today, for example, England's CPI came in at 11.1%, which is the highest rate in 41 years and well above expectations of 10.7%. Sweden, for example, has disturbingly high core inflation. So it is by no means a given that central banks believe that inflation is already on the way to being under control.

Admittedly, I also think that the Fed is about to go too far with the tightening, just as they went way too far with the stimulus. It seems that they themselves do not know how to calculate the effect of their own policies. For those of us who do not sit with detailed econometric models and seasonally adjusted data all day, it is otherwise quite obvious how it works. If the Fed lowers the interest rate until they see positive results, there is 1-2 years of fuel left for consumption and inflation. And if they raise interest rates until inflation has fallen to desirable levels, another 1-2 years of negative effects on investment, employment, growth and profits await.

Now, of course, no recession is visible in the statistics, because the figures are still affected by the lagged effects of zero interest rates and quantative easing (QE). Well, that is assuming you don't look at what the Eurodollar futures market is saying of course. There it looks even worse than it did even before the house price crash of 2007-2008. The last time when the Fed flipped from tightening to stimulus at the end of 2018, the famous “Powell Pivot”, Eurodollar futures did not have time to fall at all as much as now. In plain language, this means that a market where trillions of dollars are at stake sees an economic disaster around the corner, while Fed chief Powell promises to maintain a steady tightening course longer than he has to. Moreover, when the stock market is strong, it gives Powell an extra mandate to raise interest rates because stock-related wealth effects are one of the transmission factors for monetary policy.

The euphoria after last week's inflation figure lifted the Swedish OMX above the 200-day moving average, so there is now a small sign of a positive trend. On the other hand, it is precisely in Sweden that core inflation is particularly high. In October, the annual rate was 7.9%, which can be compared with 6.3% in the US and 5.0% in the Eurozone. This speaks for another large increase from the Riksbank - perhaps even 100 points again. But even at 75, there are many who hope to escape.

Overall, I expect that as high interest rates and utility bills slow consumption with a few quarters of lag, earnings forecasts and job numbers will soon follow suit. Eurodollar traders apparently think so too. I certainly don't think we've seen the peak for electricity prices and mortgage rates yet, which means there's about a full year to go before the negative effects peak. I therefore stick to my main scenario, that it is when the Q1 reports are published in April and May 2023 that maximum uncertainty will prevail in the financial markets. Until then, it is important to keep the risk down, use a smaller percentage of your capital than usual, avoid expensive technology companies and unproven companies in the early phase, to be ready for bargain purchases around the time of the empty chanting of the labor marches in the May sun.

Don't buy out too early, but make sure to save dry powder for the really juicy buy positions. Dry powder doesn't have to be exactly cash. For example, it could be countercyclical assets such as gold, fixed income or agricultural commodities, or even normally cyclical oil or mining companies. Among other things, it is higher oil prices that drive both the recession and persistently high inflation and high interest rates.

I hear many voices that now is the time to buy, that "everyone" is bearish. It is based on everything being unusual, i.e. like the strange special period we had in 2009-2021, when the Fed wanted to create more inflation. But now the Fed wants the opposite, and then we as investors should avoid playing heroes or fighting against the Fed. It has dangerously become a matter of course to buy all the dips since the QE and zero interest policy started in 2009. The small rebounds in 2011, 2016, 2018 and 2020 were saved directly by the Fed and are barely visible in a graph of the Nasdaq. This means that today's investors have never seen a bear market. They therefore do not know how to act in such a situation. The last bear market was fifteen years ago, and it could be interrupted only with massive stimulus. It's much harder to do this time because today's problem is inflation, not deflation. So now there will be a return to the historically more normal, where share buyers have to manage themselves on the companies' earning power instead of constantly rising valuation multiples.

It was felt in the reflexive relief rally on Friday that investors so badly want everything to be as before, that you can only buy a bunch of technology companies with questionable business ideas and cash flow, but enormous promised growth. "What you lose on a negative profit margin you make up for on high volumes and rising multiples," it says. But the point is, we're not left in Oz anymore. We've returned to Kansas after the wizard's fake magic has been exposed. However, it takes time for all hope to be extinguished, which is why we have to get used to repeated intense bear rallies in the worst medium-term investment prospects on the stock market.

It's based on okay Q3 reports, a low inflation figure, hopes of a customary year-end rally, and seemingly low valuations. It could last a few more weeks of course, but I've already started selling the usual suspects in the US tech sector again (many of ARK's holdings it often turns out). Unfortunately, I think there will be more than the employees at Twitter who miss out on this year's Christmas bonus. It is simply time to return to reality. There, a robust business idea, as well as sufficiently large profits, cash flows and balance sheets play a role. Quite a few of the last decade's winners on the Nasdaq can boast of that.

Among the relative winners, I would like to again highlight the oil and mining sectors, including the precious metals companies, plus also the large Nordic banks Swedbank, Danske and SHB. The banks and oil companies have high dividends and live on their status as safe platforms forming the backbone of society's infrastructure, and still trade at only 8-10 times earnings. They will also be dragged down in the probable race this winter, but after all, will do much better than poor Cathie Wood's future shares in her fund ARK. If you are extra risk tolerant, you can of course look at taking pure short positions on the S&P 500 or OMX via options, futures, Bull & Bear certificates or e.g. mini futures, but it is of course a risk everyone must make decisions about based on independent analysis.

Finally, a bear market isn't over until the fat lady has finished singing. Sure, Brunhilde has warmed up her voice a bit in the form of the Twitter farce and the crypto collapse with some fried bankman, but there is a lack of a really colorful record-breaking scandal. There is a lack of heavily revised downward profit forecasts, revealed Ponzi schemes and bankrupt banks and real estate companies. Yes, this whistled to a bit here and there, in the form of Evergrande in China, FTX of course, and the pranks around Twitter. But before ARK shuts down, Michael Saylor and Microstrategy are forced to sell Bitcoin, or Tesla files for bankruptcy protection, I can't believe the bottom is here. I'm looking for that day when the stock market capitulates 10 percent in a day or two because of a disclosure, after a period of decline of 10-20% in a few weeks. It's only then that I think Powell will be forced into emergency roundtable negotiations over the weekend instead of a nice round of golf with whoever he chooses for president in 2024. This time, Powell simply refuses to sing until everyone really prays and prays and says he's not a dove at all. It would be poetic if it happened precisely on May 1, 2023. After that, all central banks can say goodbye to their last little lingering credibility, and the coming era of gold and crypto, and everything that has real value and is fixed in the ground, will have a rocket launch.

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03/02/2023 10:57:19


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