Observations by David Robertson, 11/15/24

The world continues to digest the outcome of the US presidential election and is starting to model what the future administration will bring. Let’s dig in.

As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.

Market observations

Stocks started the week off with a bang on Monday with Tesla up 9%, the ARK Innovation ETF up 7% and MicroStrategy up 26%. Bitcoin was also up 5% for good measure. If ever there was a signal of pure speculation this was it. The graph from The Daily Shot illustrates the phenomenon beautifully:

At the same time, gold, and gold miners have been selling off hard. Part of this was due to a strong rise in the US dollar and part was probably just an overdue pullback after a strong run up. We’ll find out soon whether the upward trend continues or whether it’s broken.

China

The conclusion of the National Peoples’ Congress meeting last week was anticlimactic. Few new details emerged to substantiate new bullishness on China.

As the FT’s ($) Unhedged newsletter describes, however, this may be a strategic reaction to the Trump electoral victory in the US:

The timing of this package, right after the US election, suggests that the Chinese government was waiting to learn who would win the White House before making strong financial commitments. And the scale of this package raises the possibility that the government is saving its fiscal firepower in order to respond to the Trump administration’s eventual China policies.

So, we continue to wait and see. In the meantime, the yuan keeps getting weaker and the US dollar keeps getting stronger — which suggests China is more than willing to allow currency depreciation to provide leverage in trade negotiations.

Politics

The news flow regarding what the next Trump administration will look like has clipped along at a steady pace. The process of filling appointments started out appearing more professional than in the first administration and the first few individuals named seem to be considerably more competent. This is good news.

However, it didn’t take long for the less good news to start flowing in either. South Dakota Governor Kristi Noem doesn’t have experience relevant for leading the Department of Homeland Security. In addition, Secretary of Defense appointee, Pete Hegseth, is better known for leading culture wars on Fox news than managing large teams or national security.

The question marks got even bigger with Tulsi Gabbard, who has no relevant experience whatsoever for Director of National Intelligence. In addition, the appointment of Matt Gaetz strongly suggests retribution is high on the agenda. The Dispatch ($) described some of these second tier picks as being “on the very fringes of acceptability even to a Washington remade under a Republican majority.”

There are many possible motives for such selections but one seems to be to test the pliability of the Senate through the confirmation process. Regardless of the specific outcomes of that process, however, the very questionable quality of some of the candidates is likely to undermine trust in the entire process.  

Indeed, the degradation of trust in institutions is an issue Francis Fukuyama picks up on in the FT ($). He anticipates “there would be a gradual decay of liberal institutions, much as occurred in Hungary after Viktor Orbán’s return to power in 2010”:

This decay has already started, and Trump has done substantial damage. He has deepened an already substantial polarisation within society, and turned the US from a high-trust to a low-trust society; he has demonised the government and weakened belief that it represents the collective interests of Americans; he has coarsened political rhetoric and given permission for overt expressions of bigotry and misogyny; and he has convinced a majority of Republicans that his predecessor was an illegitimate president who stole the 2020 election.

The way I am looking at it, there are three important things to monitor. First, can any meaningful progress be made on some of the most intractable problems the country is facing? If so, that would be an important first step and it is important to keep an open mind on this.

Second, I am extremely skeptical the next four years will be anything but chaotic. As anyone who has gone through a corporate restructuring knows, any major change is messy. They are even messier when distinct cultures are forced together (e.g., hostile takeovers) and when change managers fail to vigilantly socialize the changes to all affected parties. Big change is only successful when almost everyone is on board. That is intentionally not the case here.

Third, while we have a real prospect of some much needed, meaningful change, it comes with the risk of losing some previously inviolable liberties. Not an easy choice, but then it has already been made. The only thing left is discovering exactly how meaningful the sacrifices will be. The answer may open the Overton window in regard to which liberties can be exchanged for “bread and circuses”. This is likely to prove a very interesting, if potentially costly, test.

Monetary policy

Every time I start thinking the Federal Reserve may be about to do something responsible with monetary policy, some event occurs and the Fed more than undoes all the progress it had made up to that point. It’s like Lucy repeatedly pulling the football away from Charlie Brown and it has left me at least mildly disgusted with the role it has played in amplifying wealth and income inequality.

Last week I mentioned how Powell’s response to the last question of the FOMC press conference indicated the Fed feels no obligation to make up for high past inflation, even though higher price levels were clearly a big complaint in the election.

In addition, while Powell was adamant that the President’s removal of the Fed Chair was “not permitted by law”, Powell had no problem breaking the law in 2020 when the Fed backstopped mortgage backed securities as well as corporate bonds. Rules for thee and not for me. By the way, corporate bond spreads are now the lowest since before the GFC.

In another interaction during the November press conference, Powell responded to a question about the Fed’s reaction function in regard to hypothetical policies under a Trump administration. He responded that the Fed only incorporated these types of scenarios once formal plans were announced and they had numbers they could model. Of course, the market starts working with these numbers right away, whether hypothetical or not. As a result, the Fed’s position almost ensures monetary policy will lag important catalysts by months if not years.

What is becoming increasingly evident now is that I’m not the only one noticing the systematic bias of the Fed (towards capital at the expense of labor), and I’m not the only one at least mildly disgusted by it. Jim Bianco put out a post with six meaningful questions for Fed policy that never get asked in the overly polite environs of the FOMC press conference. Maybe additional publicity will raise the heat on the Fed to be accountable for its actions (and inactions). This post by Brian Wesbury captures the sentiment well:

There is a mandate for change. The government never lets a crisis go to waste, and the Federal Reserve is near the top of the list. It grew massively during the 2008 panic and COVID. The Trump Team needs to focus some of its energy on the Fed.

Further, there are people like Ron Paul who suggest even more radical change: “No power was ever granted to the federal government to create a monopoly bank that manipulates interest rates and counterfeits money.” He went on, “The issue is that the Federal Reserve should not exist at all!”

This would all amount to little more than sour grapes and some venting on social media if the stakes weren’t so incredibly high. Extremely low perceived risk and extremely high valuations all rest on one very fragile premise: The Fed will always be there to sustain the value of financial assets. In the increasingly possible event the Fed becomes either unable or unwilling to step in to save assets, there is a very long way down.

Investment landscape I

THE NEXT STAGE IN WESTERN CIVILISATION - PART 2 ($)

https://www.russell-clark.com/p/the-next-stage-in-western-civilisation-68e

the world makes more sense if you understand it as the digital world is eating the physical world. The best way forward is to ignore how something looks or feels in the real world, and to focus exclusively on how it looks or feels in the digital  world.

Donald Trump is a good example, but one that readily generalises. In the “real world”, Trump was a property developer with a mixed record, a serial womaniser, was definitely involved in the storming of Capitol Hill, and has very unusual economic policies. 15  years ago this made the idea of Trump as President nonsensical, but the digital world and social media changes the calculation. Success in the modern world seems to centre on the ability to master modern social media. And modern social media tends to bypass  the traditional gatekeepers of journalists, editors, and other keepers of “mainstream” views. But what you need to succeed is the ability to be viral - to motivate people to follow you on social media. I am not a big Donald Trump fan, but I have no inclination to follow Hillary Clinton, Joe Biden or Kamala Harris on social media - and that was the key to victory. For the Democrats to recover, they need to move to a much heavier focus on social media, even cult like personalities.

I really enjoyed this piece from Russell Clark because I think it reveals some unique insight into election results. In short, a big part of Trump’s success can be attributed to more effective use of social media. Insofar as this is the case, it implies anyone who wants or needs to gain wide attention, needs to have a competent social media effort.

As Rusty Guinn ($) writes, however, it is not just a matter of applying the technical skills of using social media, it is a matter of understanding what that game has become:

It [supportive evidence] simply wasn’t accessed because in the socially networked age, the process of truth-finding has been replaced with the negotiation of the meanings of higher order complex symbols.

What I think the media have yet to (fully) realize is that mature social networks also give them the power to assign symbolic relationships to facts and events. Social networks give them the power to mediate what everyone believes those symbols mean, wholly untethered to any sense of obligation to reality. That’s when the real Cartesian Crisis sets in. Not when we realize that generative AI can effectively simulate reality, but when the media realize they can effectively define it. Elon’s delusions about social networks allowing ideas to percolate from the bottom up notwithstanding, there is only one way to avoid this future, I think.

Rusty Guinn goes deeper in order to explain why digital media is becoming so important. According to Guinn, social media creates a condition of what he calls, metametastasis, which is a phenomenon whereby “no amount of fundamental truth is clear enough, no dose of reality strong enough to offset what we consider to be true at higher, more symbolic levels of abstraction.”

In other words, the memes and imagery that make social media what it is are sort of like advertising sugary cereals to kids: The symbols and imagery make ideas look GOOD at a visceral level. Understanding is achieved with no need to consciously employ cognitive resources, i.e., to think about it. In short, it isn’t a fair fight.

This is important because it helps outline some of the new realities in politics, but also economics and every other aspect of our lives. One point Clark makes is: “The best way forward is to ignore how something looks or feels in the real world, and to focus exclusively on how it looks or feels in the digital world.” As a result, any effort requiring widespread support must have a competent digital media effort. That is now the key communication avenue between policies and people.

Another implication is the digital message is the new reality. When the “process of truth-finding has been replaced with the negotiation of the meanings of higher order complex symbols” and those symbols are created “wholly untethered to any sense of obligation to reality”, we are a long, long way from facts or science or critical reasoning being the arbiters of “truth”. Get used to it.

If this seems like a dismal forecast for where things are going, it mainly is. One coping mechanism is to drop the pretense that just explaining something better will lead to a better result. Nope. Social media has changed the game. Another step can include upping one’s social media game, as Clark suggests, in order to at least be fighting the right battle.

At the end of the day, it is hard to see how this ends well. Guinn concludes the only way is to destroy social media in its current incarnation. That may be. Until then, however, it helps to at least have a little better understanding of what is going on.

Investment landscape II

One of the common misperceptions of the market is how its structure affects changes in price. A common belief is that prices are driven higher primarily by improving fundamentals and that flows are irrelevant. This view was expressed in a recent post:

If someone adds $1,000 to the stock market, all else equal, the stock market value goes up by $1000. That means a total stock index fund is worth more. As a passive investor in the total market, I don't care which stocks go up. It doesn't matter.

However, this is wrong because it does not properly characterize what really happens in the market. The price setting mechanism is determined by the relative desire of buyers versus sellers. If buyers are more adamant, price goes up. If sellers are more adamant, price goes down.

One way to picture this, at least on the buy side, is as an auction. The stronger buyers feel about a given object, the more the price gets bid up.

In the case of markets today, the reality is that passive funds (and most stock repurchase programs) are insensitive to price. Passive funds in particular, have a mandate to buy at any price if flows come in. It’s like an auction where the buyer insists on getting the object regardless of who else is bidding.

The effect is that stock prices are elastic — which means they go up (and down) much more than flows alone would suggest. This is a point Mike Green highlights with a simple example:

So globally we have invested $15T into the stock market in the last year? No, try about $300B of net inflows and $800B of buybacks of which $100B went back out as dividends and roughly double that in stock compensation.

The point here is the $15T expansion of the stock market over the last year cannot be explained by flows alone. Rather, it is explained by the net flows (300 + 800 - 100 - 200 = 800) times a multiplier of about 19. In other words, $1,000 added to the stock market adds about $19,000 of value to the stock market, not $1,000. Oopsie, just a little off.

What this means for investors is the value of their retirement portfolios are effectively being determined by ravenous bidders who want to own stocks at any price. This works fine just so long as there are ravenous bidders and horribly when there aren’t. Don’t say you weren’t warned!

Implications

One observable phenomenon since the election is the interpretation of the Trump victory by markets as, “the casino is open!” Stocks have done well, but the most speculative vehicles have been spectacular. You can almost hear the barkers calling out, “step right up, bigger payouts than other casinos”.

As such, Trump’s win has been more of a celebration for degenerate gamblers than anything. Perhaps the new Trump administration can find a way to thread the needle and maintain strong growth while implementing massive changes and cutting costs. What the belief system really relies on, however, is the Fed being both willing and able to save the day whenever financial assets get into trouble.

Importantly, as I mentioned in the “Monetary policy” segment, not only are there inflationary risks that could impede action by the Fed, but there is also more grumbling about the very existence of the Fed. While I doubt the Fed would be disbanded altogether, I actually think there is a good chance its mandate could be fairly significantly revised in the next several years.

Either way, if and when the Fed loses its ability to freely backstop markets, and markets start picking up on this new reality, it will be a very different day for financial assets.

In the meantime, the game is on for the YOLO/FOMO crowd. Long-term investors can reassure themselves, however, that betting heavily on the most speculative stocks is not a high percentage way of securing a comfortable retirement.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

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