Skeptical Investment: 2023

*** denotes well-worth reading in full at source (even if excerpted extensively here)

Economic and Market Fare:

Damodaran: Market Resilience or Investors in Denial: The Market at Mid-Year 2023

Fear, greed and confusion!

I am not a market prognosticator for a simple reason. I am just not good at it, and the first six months of 2023 illustrate why market timing is often the impossible dream, something that every investor aspires to be successful at, but very few succeed on a consistent basis. At the start of the year, the consensus of market experts was that this would be a difficult year for markets, given the macro worries about inflation and an impending recession, and adding in the fear of the Fed raising rates to this mix made bullishness a rare commodity on Wall Street. Markets, as is their wont, live to surprise, and the first six months of 2023 has wrong-footed the experts (again). ...........

..... It goes without saying, but I will say it anyway, that the economy may still go into a recession, analysts may be over estimating earnings and inflation may make a come back (pushing up long term rates). If you have concerns on those fronts, your investing should reflect those worries, but your returns will be only as good as your macro forecasting abilities. Mine are not that good, and it is why I steer away from grandiose statements about equities being in a bubble or a bargain. While uncertainties abound, there is one thing I am certain about. I will be wrong on almost every single one of these forecasts, and there is little that I can or want to do about that. That is why I demand an equity risk premium in the first place, and all I can do is hope that it large enough to cover those uncertainties.

A Time for Humility

If the greatest sin in investing is arrogance, markets exist to bring us back to earth and teach us humility. The first half of 2023 was a reminder that no matter who you are as an analyst, and how well thought through your investment thesis is, the market has other plans. As you listen to market gurus spin tales about markets, sometimes based upon historical data and compelling charts, it is worth remembering that forecasting where the entire market is going is, by itself, an act of hubris.

GaveKal: US Treasuries’ ‘Risk-Free’ Status

.......... If the government chooses to raise funds using longer-dated treasuries, investors should buy them. On a risk- adjusted basis, the real yield offered by US treasuries is attractive relative to the return earned by the average US firm (the economy-wide corporate return on invested capital) and the equity earnings yield. This situation will tend to put downward pressure on long-term treasury yields, especially if concerns about US economic growth again come to weigh on investor sentiment (see Buy Or Fade The US Equity Rally?). In the view of Will Denyer and I, there is a high chance such a shift will occur due to the lagged effect of higher interest rates impacting demand (see It Is Too Soon To Call A Soft Landing).

Looking ahead, Fitch’s concern about a fiscal deterioration in the next three years will likely come to pass. Using Gavekal’s trusty “four quadrants” framework to think about future scenarios, US budget deficits should widen in the two most likely outcomes, namely an inflationary boom (as expected by Louis Gave and Anatole Kaletsky) and a disinflationary bust (as still expected by Will and I) ...

Hussman: Air Pockets, Free Falls, and More Cowbell

There is a particular “setup” that we’ve historically found to be associated with abrupt “air pockets” and “free falls” in the S&P 500. It combines hostile conditions in all three features most central to our investment discipline: rich valuations, unfavorable market internals, and extreme overextension. The last time we observed this combination to a similar degree was in November 2021, shortly before the S&P 500 lost a quarter of its value. The S&P 500 remains lower than it was then. Despite enthusiasm about the market rebound since October, I remain convinced that this initial market loss will prove to be a small opening act in the collapse of the most extreme yield-seeking speculative bubble in U.S. history.

The present combination of historically rich valuations, unfavorable internals, and extreme overextension places our market return/risk estimates – near term, intermediate, full-cycle, and even 10-12 year, at the most negative extremes we define.

It’s difficult to discuss extremes like this without sounding like one is “calling a top,” so I’ll repeat what I emphasized in late-2021:

“Emphatically – and this is important – my intent here is not to ‘call the top’ of this bubble. Yes, this is a bubble in my view. Yes, I believe it will end in tears. Yes, the price investors pay for a given stream of future cash flows is inseparable from the long-term returns they can expect. Yes, if this bubble is ever to actually have a top, this would be a perfectly reasonable moment to expect one. Still, my present intent is simply to share what we’re observing.”

Let’s examine these three elements in turn – valuations, internals, and overextension. .........

Investors often assume that extreme valuations imply that stock prices should fall, and that if stock prices don’t fall, the valuation measures must be incorrect. That’s not how valuations work. Valuations are informative about long-term returns and the extent of potential losses over the complete market cycle. Emphatically, however, valuations have very little to say about market direction over shorter segments of the market cycle. Think about it. If rich valuations were sufficient to drive stock prices lower, it would be impossible for stocks to reach valuations like we observed in 1929, or 2000, or early 2022, or today. ..................

There are very few conditions in which we have any specific expectations for near-term market action. The exceptions are when the market is strenuously overextended in a “trap door” situation combining rich valuations with unfavorable internals, or when the market is strenuously compressed following a material improvement in valuations.

Over the past four decades, I’ve developed scores of interesting “syndromes” and relationships, many that I’ve discussed in these market comments. A subset of these capture features of “overextension” and “compression” that occur at major market extremes.

The chart below shows one such syndrome that emerged in mid-April as the S&P 500 advanced above 4400, and again last week, which I consider part of the same overextended advance. The criteria are intended to capture a certain “relentlessness” of speculation that often precedes abrupt market losses. This particular syndrome is among several that I monitor to identify speculative “blowoffs.” ...............

Claims Show Recession Risk Is Brewing And Credit Is Mispriced

... the greatest leading information content comes not from the headline claims and continuing claims data, but what is happening at a state level. ....

MMT Fare:

Kelton: It Turns Out That No One Wants to Tell the Truth About Government 'Debt'

........... I also explained that I don’t think about government ‘debt’ the way most economists do, and I explained why I think it’s misleading to use terms like “borrowing” and “financing” to describe what’s really happening when the Treasury issues bonds. Unfortunately, the insights that come from a careful examination of real-world monetary operations, don’t usually receive mainstream coverage. If they did, they would reveal some hidden truths about how government finance really works and why editorials that proclaim America is living on borrowed money are so misguided.

Quotes of the Week:

MS: If narratives can determine economic outcomes, then they can move markets, rightly or wrongly. And they have, wrongly. Higher rates post-BoJ, Fitch downgrade, and US Treasury refunding resulted from commonplace narratives that reflect misguided perceptions that became reality for the bond market.

Vid Fare:

Lacy Hunt: Brace For A Credit Crunch + A "Serious" Recession