Observations by David Robertson, 2/16/24
With the hard-hitting CPI report on Tuesday and powerful momentum continuing anyway, it was an eventful week. Let’s take a closer look.
As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.
Market observations
Not too surprising, but as @SoberLook reports, momentum has been the outstanding factor driving performance lately.
With a great deal of attention being placed on expectations for Fed rates cuts, there has been surprisingly little attention placed on New Zealand’s central bank which may actually raise rates. Jim Bianco posted last week, “New Zealand is now discussing resuming HIKES, and they tend to lead.” Brent Donnelly also picked up on New Zealand in his Substack: “The market had priced interest rate cuts [in New Zealand] and is now back to pricing hikes. While it’s hard to imagine, this is possible in the United States too!”
Meanwhile, neither rates markets nor stocks seemed to care about the prospect.
In addition, as evidence that things may be getting at least a little out of hand, Le Shrub posted an example of “Max Stupid” on his Substack:
LYFT reported results post-market. In the outlook, they said they expected margins to increase by 500bps. The stock surged +60% in the post-market (14% short-interest helps!). Then AFTER ONE HOUR and DURING THE CALL, the CFO said it was a “clerical error” and they actually expect a 50bps increase in margins. Pity the fools who traded the stock at that spike. The stock then dropped 30% from the highs.
What’s impressive though is that the stock is STILL up 16% after the print, as if none wants to question the reporting & accounting processes, because who cares.
As he puts it, “the gullible monkeys are fully in control here”.
Research and development
Universities are failing to boost economic growth ($)
Universities are supposed to produce intellectual and scientific breakthroughs that can be employed by businesses, the government and regular folk. Such ideas are placed in the public domain, available to all. In theory, therefore, universities should be an excellent source of productivity growth … In practice, however, the great expansion of higher education has coincided with a productivity slowdown.
In the post-war period higher education played a modest role in innovation. Businesses had more responsibility for achieving scientific breakthroughs: in America during the 1950s they spent four times as much on research as universities. Companies like at&t, a telecoms firm, and General Electric, an energy firm, were as scholarly as they were profitable. In the 1960s the research and development (r&d) unit of DuPont, a chemicals company, published more articles in the Journal of the American Chemical Society than the Massachusetts Institute of Technology and Caltech combined. Ten or so people did research at Bell Labs, once part of at&t, which won them Nobel prizes.
Given my interest in research and innovation in general, this Economist article jumped out for a couple of reasons. One is the historic perspective. There was a time when the big industrial companies were at the leading edge of R&D. Think Bell Labs or the Palo Alto Research Center (PARC) for Xerox. It has been remembered as a time when big companies were willing and able to spend more on R&D at the time. There was another motive at work as well though: “Giant corporate labs emerged in part because of tough anti-monopoly laws.”
Beginning in the early 1980s priorities began to change. Enforcement of anti-trust laws became more lax and companies began to outsource R&D functions or acquire them through mergers and acquisitions. “Expertise”, especially in the form of university research, gained greater authority. This led to a big increase in researchers, but a growing gap between real world corporate R&D challenges and the subjects of most university research.
Increasingly, the university-driven research model is proving itself unworthy: “when it came to delivering productivity gains, the old, big-business model of science worked better than the new, university-led one”. As it turns out, when research is not governed by commercial interests, “research focuses more on satisfying geeks’ curiosity or boosting citation counts than it does on finding breakthroughs that will change the world or make money”.
In short, the economic benefits of science depend on a symbiotic relationship between business and science. If you want to improve productivity through public policy, the place to focus on is nurturing that symbiosis and avoiding the situation of leaving either business people or scientists solely to their own devices.
Politics
Labeling the Third-Party Movement ($)
https://thedispatch.com/newsletter/morning/labeling-the-third-party-movement/
Third-party presidential candidates historically have had terrible odds, but No Labels isn’t the typical third-party effort of recent years … Founded in 2010 to encourage more bipartisanship and common-sense policy making, the group says 2024 may get weird enough for a non-major-party candidate to win: If—and only if—polling shows a path for a successful independent bid, the group will field a unity ticket likely consisting of a centrist Republican and Democrat.
The group’s theory of victory hinges on the fact that Biden and Trump are incredibly unpopular. A January NewsNation/Decision Desk HQ poll found that 59 percent of respondents were not enthusiastic about a Trump-Biden rematch. What’s more, 63 percent of American adults believe that the Republican and Democratic parties do such a poor job of representing the American people that a third major party is needed, according to an October 2023 Gallup poll—the highest level since Gallup began asking the question … The group commissioned a December 2022 national poll in which 59 percent of respondents said they’d be open to voting for a “moderate independent” for president if the alternatives were Trump and Biden.
The point here is not to dramatize or hyperbolize the chances of a major third-party candidate this year. Even the No Labels group admits, “Americans like the idea of a credible third-party ticket, but have very different opinions of what that ticket should look like.” However, the group also notes observers “are underestimating the depth of frustration that the public has with their current choices.”
So, one point is No Labels is organized and well-funded and therefore quite credible if the opportunity for a third major candidate arises. In addition, the effort by No Labels is itself indicative of the “depth of frustration that the public has with their current choices”. Very true. All this points to the distinct potential for something really wacky to happen by the end of the election.
Monetary policy
Desperately Seeking Neutral
https://www.mauldineconomics.com/frontlinethoughts/desperately-seeking-neutral
“The concept of a neutral stance of monetary policy is critical to assessing where policy is now and what pressure it is having on the economy. While we cannot directly observe neutral, economists have models to estimate it, which are imperfect even under normal economic circumstances. Our various workhorse models for the economy have struggled to explain and forecast the pandemic and post-pandemic periods given the extraordinary changes and disruptions the economy has experienced. So I also look to measures of economic activity for signals to try to evaluate the stance of policy.
This piece from John Mauldin provides a nice discussion of the thought process behind monetary policy. The quote from Minneapolis Fed President Neel Kashkari, in particular, highlights some critical elements of the process. One is that the models used to frame monetary policy are “imperfect even under normal economic circumstances”. Further, the pandemic and post-pandemic periods have involved disruptions that make the task far harder than usual. The bottom line is the policy process is “highly subjective”.
While none of this is especially new or controversial, it leads to a few useful ideas. First, because of the inherent uncertainty of both the underlying data and the decision-making process, there is no edge in betting on a particular path of monetary policy. Relatedly, while real rates offer one perspective on monetary policy, it is only one of many.
Finally, and I think this is one of the most frequent mistakes made by investors, this isn’t just a game of figuring out the very best monetary policy. Setting monetary policy is an inherently political endeavor and as such, central bankers are vulnerable to being made scape goats if anything goes wrong. Any consideration of monetary policy should also consider which course carries the least political risk given the array of possibilities.
Investment landscape I
‘Enshittification’ is coming for absolutely everything ($)
https://www.ft.com/content/6fb1602d-a08b-4a8c-bac0-047b7d64aba5
So what’s enshittification and why did it catch fire? It’s my theory explaining how the internet was colonised by platforms, why all those platforms are degrading so quickly and thoroughly, why it matters and what we can do about it. We’re all living through a great enshittening, in which the services that matter to us, that we rely on, are turning into giant piles of shit. It’s frustrating. It’s demoralising. It’s even terrifying.
But in case you want to be more precise, let’s examine how enshittification works. It’s a three-stage process: first, platforms are good to their users. Then they abuse their users to make things better for their business customers. Finally, they abuse those business customers to claw back all the value for themselves. Then, there is a fourth stage: they die.
This is a very cynical, but accurate, take on the business models of big tech platforms, and increasingly on platforms across the business universe. The bottom line is these companies have refined a strategic approach that effectively monetizes public goods like personal data privacy, civil discourse, teen mental health, and the like. It’s not that they don’t provide some useful functionality, they do (or at least did). Rather that functionality is primarily used in a bait and switch maneuver that lures them in, gets them locked into the network, and then progressively dilutes the benefits and increases the costs.
Here are a few choice nuggets regarding Facebook:
To the advertisers, Facebook said: Remember when we told those rubes we wouldn’t spy on them? Well, we do. And we will sell you access to that data in the form of fine-grained ad-targeting. Your ads are dirt cheap to serve, and we’ll spare no expense to make sure that when you pay for an ad, a real human sees it.
To the publishers, Facebook said: Remember when we told those rubes we would only show them the things they asked to see? Ha! Upload short excerpts from your website, append a link and we will cram it into the eyeballs of users who never asked to see it. We are offering you a free traffic funnel that will drive millions of users to your website to monetise as you please. And so advertisers and publishers became stuck to the platform, too.
One might say those companies are free to operate as they see fit so long as they don’t break the rules. That’s a nice idea, but the platform approach specifically and vigilantly worked to undermine the normal governors of bad business behavior such as competition, regulation, self-help, and workers. For example, tech workers are increasingly learning how little power they have in the relationship with their employers:
Workers are no longer a check on their bosses’ worst impulses. Today, the response to “I refuse to make this product worse” is “turn in your badge and don’t let the door hit you in the ass on the way out”.
What all of this amounts to is tech executives have had progressively weaker forces to hold back their worst tendencies. As the author notes, “Executives weren’t better before. They were constrained . . . by competition, regulation, self-help and worker power”.
One question that immediately pops into my mind is, “Why are we seeing this now?” The anti-competitive behavior, dishonest dealings with consumers, advertisers and regulators, et al have been fairly evident from the early days. Nobody cared. Partly because the costs to society are increasing (and increasingly evident) and partly because the perceived benefits to consumers are decreasing, these issues are increasingly becoming political problems.
That raises another big issue. While the big tech companies are certainly generating big profits right now, their operating models are becoming increasingly fragile. As the author reports: “But that’s a very brittle equilibrium, because the difference between ‘I hate this service, but I can’t bring myself to quit,’ and ‘Jesus Christ, why did I wait so long to quit?’ is razor-thin.” Indeed it is. And once that equilibrium is tipped, things can unravel quickly.
Investment landscape II
The Consumer Price Index (CPI) was reported on Tuesday morning and the numbers came in hotter than expected. After the report at 8:30, but before the open, S&P 500 futures were down 1.34%, Russell 2000 (small cap) futures were down 3.47%, the 10-year Treasury yield was up 10.5 bps, the VIX index (volatility) was up, the US dollar was up strong, and gold, especially gold mining stocks got pounded.
This is interesting because it says so much about narrative-space right now. First, stock prices say next to nothing about fundamentals or intrinsic value, but they do say quite a bit about prevailing narratives. The strongly negative reaction of stocks, bonds, and gold to the CPI print suggests the prevailing narrative was focused on multiple rates cuts by the Fed. A higher CPI pushes back the date when the Fed can start cutting rates and reduces the number of likely cuts this year.
The assumptions in this narrative are that the Fed still retains a great deal of control over the economy and markets and that inflation is all but dead. The only questions are when and by how much the Fed will goose markets again.
This also captures a couple of vulnerabilities in current sentiment. First, there is still room for rate cut expectations to come down even after Tuesday’s move. There is also room for these adjustments to disperse more widely through stocks and financial companies.
Another, much bigger vulnerability, is if inflation turns back up again. That would take rate cuts off the board altogether and might even demand rate increases. Everything stocks gained since last fall was predicated on the notion that this little episode of inflation was over. If that premise is wrong, the gains realized since then will likely be given right back.
Given the inherent uncertainty in inflation and the fact this is an election year, there is probably enough room for the Biden administration to manage the narrative to keep inflation expectations from becoming too hot or too cold for most of the year. At some point however, probably later in the year, the surging deficit and the need to monetize it will become increasingly evident. That could very well set up a “big bang” moment when inflation expectations get reset a step function higher.
Portfolio strategy
About a week ago, Ben Hunt posted this follow up on X in regard to the incorporation of gambling into professional sports:
The silent transformation of capital markets and sports into a reference index for derivative bets by the proles (with an enormous rake, of course) is the biggest societal transformation of the past 20 years.
This is a pretty dense statement so let’s unpack it a bit. In doing so, I’ll stick with the capital markets application though.
A reference index is a standard against which to determine success or failure. Derivative bets are indirect bets. For example, rather than finding cheap stocks or waiting until they are cheap, you bet on the Fed cutting rates 6 times this year. Proles, of course, are the masses, i.e., ordinary folk. The “rake” is the cut the host of the game takes in for hosting the game.
Putting it all together means capital markets have become functionally more similar to gambling than they are to investing. You bet money on something happening, you either “win” or “lose” the bet, and either way, you pay commissions and trading costs for the privilege of doing so. This is easiest to see in gamified trading apps, but it is apparent everywhere. The constant flow of “news” provides a constant flow of new things to bet on. It’s all become so normalized it’s easy to forget what the original purpose of capital markets was to begin with.
When virtually nobody does the work of evaluating the quality of investments, and instead place derivative bets on monetary policy or unemployment numbers or artificial intelligence or whatever, capital is not efficiently allocated and productivity goes down. This isn’t something that happens overnight, but over time can very substantially erode the productive capacity of an economy. This is happening.
As a result, one of the most important things investors can do right now is to decide which type of game you want to participate in. Sure, you can bounce around and trade whatever the hot idea du jour is, and it can be fun to do so, but the long-term odds are not with you. In other words, it is not investing at all and therefore not a good way to fund retirement.
Alternatively, you can recognize that most trading ideas are losers’ games in the long-term and avoid them. Instead, you can independently evaluate various investments, or hire someone who can, and determine the best and most appropriate risk/reward opportunities on offer. As hard as it can be to tell from current market evidence, investing is not a game.
Implications
I have talked several times about how monetary authorities at the Fed and Treasury both use narratives to frame and shape the interpretation of facts on the ground to suit their objectives rather than to inform.
What I have talked less about is the market’s capacity to come up with its own narratives as that may or may not dovetail with other narratives. Clearly the artificial intelligence is going to the moon narrative is taking on a life of its own right now.
The implication is investors can get the rug pulled out from under them in either case. It doesn’t matter who started the narrative. All that matters is narratives tend to amplify swings away from underlying fundamentals and it’s best to either avoid the swings altogether or at least beware of the volatile proposition you are participating in.
Note
Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.
Disclosures
This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.
This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.
This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.