Category Archives: Stocks

Pied Piper

We had a bit of selling yesterday after Janet Yellen threw cold water on the idea of insuring all deposits by executive order, but of course the dip is being bought overnight because… Actually the market is being led higher by the usual handful of “tech” stocks, in turn being led by Nvidia. This seller of video cards has had a good run from crypto, where the parallel computing power of the graphics chips can be effectively utilized. But it is winter in crypto land (yes, I know Bitcoin is running but it is lonely) so Nvidia needed a new story. Press releases followed mentioning AI (plausible) and quantum computing (not so much). Anyway the stock has taken off again, now on offer for a mere 25 times sales. Yippee.

Bank Runs

Silvergate Capital, a bank known for its ties to the crypto industry, said yesterday that it would voluntarily liquidate. Today Silicon Valley Bank, known as close to the venture capital industry, was closed by California regulators. Both are somewhat special cases, so aren’t necessarily a sign of general distress.

However, it is fair to say that banks are pressured on both sides of their balance sheets. On the asset side, interest rate increases have caused securities portfolios to drop in value. On the liability side, short-term Treasury securities offer a safe and highly liquid alternative to bank deposits, forcing banks to either raise the interest that they pay or accept the loss of deposits needed for liquidity. So far most banks have chosen the latter, but it is a risky choice, as evidenced by Silicon Valley Bank, which was forced to sell its entire tradable securities portfolio at a significant loss in an attempt to shore up liquidity. This situation illustrates the two ways banks can fail – on the asset side, losses on loans and securities reduce the bank’s capital so that it cannot continue or, on the liability side, withdrawals deplete the bank’s liquidity – cash if you like – so that it is unable to meet the demands of depositors.

So far the impact on the broad stock market has been negligible, probably balanced between fear of a financial meltdown and confidence that a tremor in the banking system would force Powell to pivot. GLWT.

Edit: From an anonymous VC to a portfolio company CEO: “Our view is that this is a sector-wide issue. We’re advising founders not to use a bank right now. We’re pooling together our portcos’ capital and executing a large batch transaction for Starbucks gift cards. Starbucks is likely more stable than banks (they’re on every corner and everyone drinks coffee).

To cash out, we’ll just buy a bunch of those dipped madeleines they have near the checkout. Best case we make back 98 cents on the dollar. Worst case, we have a few million cookies that have a long shelf life.”

Of course the portfolio companies will never see that cash – the cookies won’t make it past the break room at the VC outfit.

Volatility Suppressed

For nearly three months now, 0DTE (options expiring within 24 hours) players have suppressed volatility. Any intraday increase in VIX is quickly met with mean-reversion trading of options which effectively counters all but the strongest of trends. The problem with this is that suppressed volatility eventually breaks out of its cage. The last time this happened was in 2018, and the event is now called “Volmageddon” or “Volpocalypse”. VIX doubled in a short time, which was not too serious for the major indexes but wiped out a number of leveraged VIX-related ETFs. This time the potential risk is much larger because the volatility suppression is really a side effect of an options strategy which is able to directly cause a major move. JP Morgan estimates that a 5% move in the S&P would trigger a further 20% crash as the options writers moved to hedge their positions by selling stocks and futures. But to further aggravate the situation, the open interest in VIX calls is at an all-time record as some traders believe this suppression cannot last indefinitely, and will blow up at some point. A sudden rise in VIX would cause these calls to create a gamma squeeze in VIX, driving VIX still higher and increasing the selling by the options writers. More than $1 trillion notional of 0DTE options are being traded every day. This is idiocy. The selling would be entirely automated, just like the “portfolio insurance” that caused the 1987 crash.

OTOH there’s a lot of idiocy around right now. A clue is that “Mr. 50 cent”, a very large and successful VIX options trader known for the signature habit of buying large quantities of options for, well, 50 cents, has taken a call position. This person (or fund) is not an idiot and has been absent for a while, after racking up an estimated $200 million profit in the 2018 event. In all fairness that $200 million was actually a $400 million profit offset by $200 million in losses stemming from being early. That’s conviction.

Something’s Going To Break

From past experience, we can be pretty sure that the bear market doesn’t begin until the inverted yield curve returns to a positive slope. Usually this happens because of a major disruption in the financial markets. Here are some of the opportunities for breakage.

  • The average 30-year mortgage rate, as of today, is 7.13% according to Bankrate.com. Housing affordability has dropped to what Redfin deputy chief economist Taylor Marr calls the “lowest level in history.”
  • Office occupancy in major city centers is ranging from 40-60% as a result of WFH practices. Pressure on bricks-and-mortar retailers from online shopping continues to build. The overall US CMBS delinquency rate jumped 18 basis points in February to 3.12%. (The all-time high on this basis was 10.34% registered in July 2012. The COVID-19 high was 10.32% in June 2020.) . Giga-investor Blackstone just defaulted on $562 million of CMBS.
  • CPI/PCE inflation continues. While energy prices continue to be contained by withdrawals from the SPR, labor prices continue to increase. Fed chair Powell says that his primary measure of inflation is core PCE less housing, which implies a heavy weight on labor costs when evaluating inflation.
  • The Fed continues to raise short-term interest rates to reduce business activity and therefore reduce inflation. So far with little success. Financial markets are busily fighting the Fed’s attempts to tighten financial conditions. History says this does not end well.
  • There’s a war on, into which black hole the US continues to pump money and armaments. These will need to be replaced at great cost. Defense spending will be increased. The big risk is of further escalation, which could include the use of nuclear weapons.
  • The primary source of inflation is deficit spending by government. Half of the government’s debt has a maturity of less than five years. The Fed’s rate increases are quickly running up the government’s interest bill, which of course will increase the deficit – that’s how the black hole works. Interest is already nearly as large a budget item as defense spending.
  • China’s recovery from its draconian COVID policies is limping badly after a small initial surge. In addition, the US is actively hampering the development of technology in China and relations are a historic lows. There is a significant risk of another war, this time over Taiwan, where TSMC is the crown jewel of semiconductor manufacturing. All this means that China is unlikely to be the source of cheap manufactures goods that have helped quell inflation for the last twenty years or so.
  • The US stock markets remain highly overvalued and not investable as the flood of liquidity during the COVID era has supported speculation. The options market has grown to be larger than the equity market of which it is supposedly a derivative, leading to extreme gambling activities such as 0DTE options..

Get the idea?

Honne And Tatemae

There are many financial conditions indexes, but in general terms they represent the cost and availability of credit and equity financing, interpreted as relatively “tighter” or “loose, easy”. Markets were surprised that Powell appeared unconcerned that these indexes showed that financial conditions were more or less unchanged by the Fed’s rate and QT actions. His unconcern was interpreted as conceding that the bulls were right in believing that rates would soon come down.

My interpretation was that he simply didn’t think it was a problem. One of the Fed’s primary concerns is to keep financial markets functioning normally, and the indexes show that they are. However, it is important to remember that the Fed is very well informed. The Japanese have words for this, “honne” and “tatemae”. “Tatemae” is the outward appearance of conformance to society’s norms and rituals, while “Honne” is what is really going on behind the scenes. In this case, the “Tatemae” is the traditional information bureaucracy – the BLS, BEA, and even the Fed itself – and the ritual announcements of  lagged and often politicized estimates of economic data. The “Honne” is that the Fed uses all kinds of information services and is very much in touch with the high-frequency data that is gathered by state governments, industry associations and many other private services. The recent callout of the BLS by the Philly Fed shows that the Fed has little faith in the BLS. Powell knows that the economy is either on the verge of recession or already in one regardless of the NBER’s view. He knows that deflationary collapses are underway in markets like housing and used cars. He probably also expects that taking down inflation, as happened in the GFC, will likely require a severe correction in financial markets, probably worse than the GFC. But I am of the opinion that  he is willing to be wrong about that, so if markets are right to “look through” the recession to a return to low inflation he would be perfectly OK with that. He did warn that no rate reductions should be expected in 2023, nor would he back off prematurely, but this was widely ignored.

Edit: This morning’s employment report demonstrates the useless, erratic nature of the BLS data.

Happy Days Are Here Again

Markets continue to behave as if 2022 never happened, inflation is dead, growth is strong, the Fed is impotent, we’ve had a soft landing and caution can be thrown to the winds. Stock prices have resumed their uptrend and new highs are soon to be seen. After all, the Dow is only down 7.5% from its all-time high close, and the S&P only 15%, dragged down by the big tech stocks, which are recovering fast from irrational selling, thanks to cost reductions from layoffs. VIX, the volatility index, is at levels last seen in early January last year, close to the December 2021 all-time stock market highs (18.06 as I write). Perhaps that is not a coincidence.

To me, this looks like an opportunity. Far be it for me to rain on a parade, but this looks like a bull trap.

Unwarranted

From the minutes of  the Fed’s 12/13-14 meeting:

Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.

Per Bloomberg, financial conditions are now back in pre-QT, super low rate – i.e. bubble – territory.

Fin Cond Index

This isn’t going to make Jerome Powell happy, is it? Could 0.50 be back on the table? Just to get the markets’ attention…

What If?

The stock and bond markets are depending on the recession to “force” the Fed to “pivot” back to money printing and ZIRP. The economy is addicted to free money and is slowing rapidly now that it has been withdrawn. The bond market has already priced in disinflation and Fed easing, and the stock market has been buoyed accordingly, proceeding from short squeeze to short squeeze since June of 2022.

But what if Powell has decided that the QE policies that have yielded only $1 of GDP growth for every $10 of fresh debt are toxic and the addiction must be broken, no matter what the symptoms of withdrawal might be? That his legacy will be having returned the economy from dependence on continuous stimulus to sustainable growth? To say nothing of reducing the Fed-induced income inequality that is being exacerbated by inflation? That would certainly earn him a niche in the financial Hall of Fame, perhaps next to Paul Volcker.

Froth

While a little of the massive cash pile that resulted from the Fed’s monetization of Treasury debt has been whittled away, there’s more than enough left to continue to encourage the manic speculation that we’ve seen in recent years. A week ago yesterday, Thursday, January 5, Bed Bath and Beyond (NYSE: BBBY), a past favorite of meme stock traders, told investors that ”there is substantial doubt about the Company’s ability to continue as a going concern.”

The stock closed that day about 30% lower, at $1.69. The following day, Friday, it closed another 23% lower, at $1.30 – fair enough for a company that had just issued a bankruptcy warning. But starting on Monday, the meme stock traders started a bull run and took BBBY along for the ride. On Thursday – yesterday –  the stock touched 5.87, a 350% gain from last Fridays’s close. Today, it closed at 3.66, a 180% gain from its low close and a 52% gain from its pre-news close.

This is not investing. This is the kind of speculative frenzy that is generally called “froth.” As in “frothing at the mouth” or “rabid.” “Froth” is at tops, not bottoms.

Edit: Just noticed that Bitcoin is back over $20K. Despite the continuous drumbeat of frauds, hacks, rug-pulls, SEC lawsuits, defaults, bankruptcies etc. Another sign of speculative fever.

Edit: I guess it is everywhere. “Lotto Madness” is back. Two months after a record-breaking $2 billion jackpot, another winning ticket, sold in Maine, is worth an estimated $1.35 billion. Odds of a jackpot-winning ticket: 1 in 302,575,350.

Kumquat

Recession is here. The official dating will come later, much later. But the economy is slowing quickly. Commodity prices are falling due to lack of demand. Property – real estate – is slowing. China is struggling with Covid – and trying to infect the rest of the world with whatever variants they have incubated over the last couple of years. Europe is struggling with the Ukraine war and self-inflicted wounds from sanctions and immigration.

But equity markets don’t care. The S&P 500 looks to be making a bottom at a level that was the May bottom. The Dow seems to be heading for all time highs. Only the NDX seems to be close to a new low as some hypervalued “tech” stocks have been clobbered.