Sell The Rumor, Buy The News

1550 words – a 5 minute read.

I don’t think that’s the way the saying is supposed to go but with so many things so up in the air I guess anything is possible. It is the Age of Speed and speed can cause confusion, right? 

Omicron rumors hit and traders pound the sell button, Fed inflation flip flop sparks rumors of 3, maybe even 4 rate hikes, next yr. (in hindsight it may prove to be a top tick) and traders pound the sell button. The selloff over the past few weeks has been intense and much more painful than the 5% top line index “pothole” pullback would suggest. How painful? MS’s Global Risk Demand Index is at decade low, suggesting a solid entry point for stocks while GS noted major degrossing by US L/S HFs and JPM highlighted how the CTA community had a “violent” unwind.

We know the “pothole” playbook by now – rally, get overbought (recall S&P was up 16 of 18 days at one point last month), a rumor hits, machines take over and sell the heck out of things over 2-3-4 days and then technical levels are hit and things stabilize. A sentiment reset vs a trend break is how the technical guys put it. 

Speed of science meets speed of markets with each of the now 4 Covid selloffs shorter than the prior one – we may start to think about variants as like a steam pressure cooker – every once in a while it makes a noise and until you hear it a few times it makes you jump – but its just another variant that will scare investors, put the machines to work and keep the bullishness from getting too intense – more frequent, but less deep, risk asset corrections could be the near future of investing.

Sentiment shifts from overly bullish to overly bearish (current retail & advisory sentiment back to Spring 2020 lows), positioning shifts from long & crowded to clean & under owned. I noted last Friday  that the market action seemed “perverse to me” as investors sold those segments, like Cyclicals, most exposed to the consensus outlook for above average growth and above trend inflation & bought the most expensive, most crowded names (see Apple spike) which BTW, are also the most exposed to said consensus outlook. Shouldn’t it be the opposite?

Well, often wrong but never in doubt is a phrase I have heard before. My lived experience of 30+ years in the markets suggests that rather than further aggressive selling ahead, the most likely path, Wall St’s famous pain trade”, may well be a rip higher. 

Here’s how it could go: we had the inflation print – as expected – inflation bogeyman losing ability to scare as markets had already sold off yesterday to buy today. In a way a nice retest of the selloff, 2 day bounce, retest yesterday and now up as I write. Fed next week – anyone not know the Fed will accelerate taper and the dot plots will show several hikes next year? Anyone? 

Sell the rumor, buy the news; fixed income markets have already priced in 3 hikes and a possible 4th. Steve Blitz at Lombard, an experienced guy, has shifted his 1st Fed rate hike from Sept to June and now to March. The UST yield curve last week was so flat it mimicked the depth of Covid fear back in Spring 2020 – does that seem right to you? Definitely not right to me. 

Inflation reports have a strong mechanical element to them as base effects swing from pumping monthly #s up as witnessed these past few months, to causing monthly #s to plummet early next yr. as big 2021 inflation readings fall out of 2022 reports. Bloomberg consensus suggests inflation peaks this month and falls by over 50% by March – yes, inflation over 6% in 12/21, down to 3% in 3/22. Still above trend (2% over past several years pre Covid) but sure seems, dare I say, pretty transitory to me.

Thus 2022’s Big Risk – an overly aggressive Fed – could be overstated. If consensus is right then by the time the Fed starts to hike, inflation will seem to be plummeting, perhaps even raising fears of a slowdown. Rate volatility is likely to be a feature in 2022 – I continue to expect 2 hikes at most & the 10yr at 2% by mid 2022.

So we get clarity on Omicron – right now it looks like more transmissible but milder with some protection afforded by vaccines. Speed of science suggests a specific Omicron vaccine could be ready in mere months (Covid Speed – from 10 years for vaccine pre 2020 to 1 yr. 2020-2021 to now 3-4 months – and you want to bet against that – I don’t). Pfizer and others have anti-viral pills that are likely to be approved for US distribution THIS month. 

Ok so Omicron is discounted, Fed & inflation too, sentiment is supportive, seasonality is supportive, positioning is supportive as is the history of 90% down volume days & huge VIX spikes over the coming 1,3, 6 months. What isn’t discounted? How about 15% nominal US Q4 Growth (Atlanta Fed Nowcast at 9% + 6% inflation = 15%) and the likelihood of attendant good earnings come mid January. How about continued negative real rates out thru 2022? SPY trades at 19x forward - cheapest since early 20 and vs 19x pre Covid when GDP growth was 1/3 todays and the 10 yr. yielded 1.9% vs 1.5% today.

MS reports continued strength of earnings revisions going into Q4 and next year, noting that 4Q 2021 estimates are up 13% YTD vs. the 20-year average of -7% (4Q revision from start of year through 11/24 of each year). The out year estimate (2022 in this case) is up 14% YTD vs. the 20-year average of -3%. These revisions upward this year for 4Q and the out year are also much stronger than the last two years which were negative. I expect solid earnings growth coupled with deeply negative real rates to continue to underpin risk assets in 2022.

We went through our model portfolio review this week and while some technical damage has been observed by the under the radar selloff we also saw many good tests of support and holding of support. We also found some nice entry points for positions we have been watching for months. Our big moves were to reduce US tech exposure and add to China equity exposure.  

On the thematic front headlines scream bear market with poster woman Cathie Woods of ARKK fame admitting to “soul searching” – that’s bullish not bearish.  Many of these stocks have been in bear markets for the past nine months and have essentially round tripped the entire Covid move. Comparing the present outlook with the 2000 Tech bust is completely misguided – did the Tech bust have trillions and trillions and trillions of spending from Govts across the globe coming down the pike as we will in the Climate Decade ahead? No. Thematics look interesting, especially for LT investors. 

We want to buy the laggards in the current environment, especially ones as beaten up and unloved as Chinese equity (China trades at roughly 40% discount to US equity and short China is one of BofA’s FMS Top 5 Trades). Our theme is “China 2022 glide path” and we expect the full policy quiver to be brought to bear as seen just this week with China’s credit impulse turning up & the PBOC RRR cut. We expect more to follow as 2% inflation & a strong RMB (2021 trade surplus 2nd best ever) provide plenty of scope. 

We see China FI as among the most attractive in the world. Evergrande finally defaults – what happens – assets rally – China is the best performing major equity market over the past one month – up roughly 5%. Cheap growth with full policy backstop, a strong FX with Govt noting “Stability is our top priority”… yes please, I will have more of that.

We remain of the view that 2022 will be a year of clarity, of synchronized global expansion (note Asian reopening with V strong export data) & above average global growth & declining but above trend inflation with Europe and Japan both growing strongly & China on its glide path. 

We don’t want to go back to the 2010s of low growth and low inflation; the (unpriced) opportunity set lies in a period of above average growth, a la the 2nd H of the 1990s, the last time the US enjoyed a cap ex boom and productivity surge – I think both are likely in 2022-2025. 

It could be a global theme given Europe’s Next Gen spending, Japan’s imminent fiscal stimulus, the Biden twin bill infrastructure plan, climate mitigation on a global scale etc. As noted last week, abundant capital on a regional scale is driving the Tri Polar World. Here is just one example; ytd, Europe has created 3x more Unicorns than China – VC fund raising is equal across the two. That’s a change.

Its easy to be bearish – all the cool kids are – that’s another part of my lived experience – I never really wanted to be a cool kid. Not my quote but I think this nails it: “So this is where BTFD battles GTFO the hardest”.

Happy Friday – good luck with the holiday shopping!