Degenerate Business School

The lurid collapse of FTX and with it Crytpo sentiment the world over bring to mind an old adage in high Finance. When the tide goes out, we find out who was really swimming naked. And it turns out, in the far off Bahamas, Sam Bankman-Fried was not only swimming naked. He was riding a jet ski that you paid for. 

What do we really mean? That in the end, the recent mania surrounding Crypto was only sustained by central bank policy. Put that much liquidity in the system, and the frontier of the risk curve, say a token like FTT, or any other crypto project with dubious innovation to recommend it, will rally. But drain liquidity, raise interest rates, crush institutional appetite, and an exchange collateralized only by the belief that Crypto was the future was bound to go bust. Say what you will about potential criminality. Bear and Lehman made the same mistake. Excessive leverage built on lofty valuations will always form dry grass for the next brushfire to carry out. 

In times like these, though, it is too easy to write off the whole space as trivial or deserving of its inevitable comeuppance. Every innovation is left for dead more than once. Even the internet was disparaged as little more than a cute version of the Fax machine. Until it became evident only in hindsight that it was just as consequential as the industrial revolution. 

In the end, it does force us to re-examine what projects actually have use cases, far off as they might seem. As ever, we discuss. 

Last week, Jerome Powell took the mic. And with the mystic language of macroeconomic policy said the equivalent of: we can't stop, won't stop, murdering your equity portfolio until inflation improves. Makes sense. The last best hope of a near term pivot died there on the podium. Practically speaking, the Fed will be hawkish throughout 2023.

And so the S&P 500 lurches onward in No Man's Land at ~3,770. Who will win the day into year-end? Bulls or Bears?

Earnings season began this week with mixed results. And if there are two companies that tell the story of these times, they are Snapchat (SNAP) and Schlumberger (SLB). Snapchat you surely know. Once the darling of young people sending ephemera to each other during lockdown, it is now little more than a glorified penny stock sent reeling from its soaring pandemic-era valuation. A dreadful year for tech, social media most of all, and another dreadful earnings call to mark its passing. Schlumberger on the other hand sounds like a retail outlet for elderly European equestrians. It is in fact an Oil company. And its star is on the rise. The so-called Great Rotation, from overvalued Tech to undervalued Commodity companies, continues. 

Which begs a recurring question of this podcast? Are we entering the Last Great Age of Oil? A final shortage that will send commodity prices soaring and with it the profits of the fallen Oil Giants? Or will a recession wipe demand off the board? For the purposes of investing, does it even make sense to chase the rally in Oil, or has the opportunity already passed? 

This week inflation came in hot versus consensus. And while we have past the peak of so-called headline inflation, with energy costs abating somewhat, CORE inflation is still accelerating. Rent costs in particular are running wild. What does it all mean? As was, the Fed still has a data-driven license to hike rates with abandon. And in the equity markets, the price action around Thursday's print suggests traders have no conviction about the direction of travel in the S&P 500 over the medium term. They are only degenerately trading day to day moves. 

If we look then into the murky future, more downside feels more likely than not. Simply because there are no bullish catalysts to overcome the pall of Fed hawkishness. Patience remains the game. So with nothing to do but wait, we discuss Elon Musk's ongoing evolution into a movie character. You and I might pass the time watching TV or working out. Elon buys social platforms and tries to broker Putin-friendly peace deals. What does this portend for the future if technology entrepreneurs with unlimited wealth accrue supranational power? 

Every once in a while, we get to the point in financial markets where all that matters is...wait for it...you guessed it...BOND MARKET LIQUIDITY. In the simplest terms, there are not enough willing buyers to scoop up US treasuries. Or any government bond for that matter. Least of all, as was this week, British government debt. So dire did circumstances become in London that the Bank of England was forced to ease again and become the buyer of last resort. At the death, many pension funds were saved that otherwise would have gone out with the tide.

But how did we come to this road? With the benefit of hindsight, or the foresight that very few had (like Joseph Wang), it all appears to be the work of quantitative tightening. With the Federal Reserve no longer buying treasuries with abandon, another buyer must emerge. But no such buyer exists, at least not at the margin or at least not at this scale. Tack on the global shortage of dollars needed by foreign central banks to service dollar denominated debt. And we get EPIC volatility.

Some Finance Twitter experts like Lyn Alden have long argued that this dynamic is the real test for Central Banks. They might ideally like to keep tightening until inflation softens to 2%. But what might in the end trigger a pivot first is actually disorder in sovereign debt markets. The actual market that matters for all other markets. 

This week the European energy crisis took center stage on Finance Twitter. Is this right and truly checkmate for Europe? With Vladimir Putin throttling natural gas, and no longer under the pretense of scheduled maintenance, what does the winter hold for, say, German Industry?  The Germans might have enough in storage to weather the cold, but what will prices look like for European citizens and businesses?

All of this has led to massively negative sentiment. Erik Townsend of Macro Voices ended his podcast this week with a prediction that the world might be ending. Well, at the very least he said the Halcyon days of cheap energy and easy living for the West are done and that World War III is at hand. Which was also his way of saying that commodities will become exorbitantly expensive over the next decade. 

Back in North America, we revisit the topic of Fed Policy. Sure enough, inflation and unemployment are the watchwords. But what about credit market liquidity? If that seizes up, they might be forced to waffle earlier than inflation would otherwise allow. So we turn to credit spreads. 

With the eyes of Finance Twitter fixed on Jackson Hole, Jerome Powell coolly reminded the investing public that a pivot is not in the offing. And if there is no self evident pivot, then the fever dream that was this summer's bear market rally might right and truly be over.

Of course no one really knows as yet whether we're actually in a bear market or a bull market. Such is the divide in opinion around the Fed's actual willingness or ability to remain hawkish. Inflation might be the dragon of our time, in need of slaying at all costs. But is that even possible at the pinnacle of a generational debt cycle? Can the debt burden even coexist with a properly hawkish Fed. 

Either way, volatility looks poised to increase. But will it be a garden variety oscillation higher, or a proper capitulation and puke that sends the VIX to 40? The fabled next leg down? We discuss.

Last week, the Finance Twitter newsfeed produced an embarrassment of riches. Just to enumerate the highlights:

• Nancy Pelosi visited Taiwan and sent the CCP into a frenzy 
• The jobs report blasted consensus, making way for more Fed hawkishness
• Amazon bought Roomba, completing it's conquest of your home
• Michael Saylor stepped down as CEO of Microstrat to work on Bitcoin full time
• BlackRock announced it will now offer bitcoin trading for institutional clients

Which of course bears not at all on the state of technicals. But it does appear that Friday's jobs report was the narrative capstone to a rally in the Nasdaq, that by all technical standards has reached very overbought levels. Is this the point of exhaustion, in the near term at least, for the counter rally?

What do we make of this rally? Is it a 2005 Donovan McNabb pump fake? That is, a bear market rally? Or the beginning of a pivot to accommodative policy once more? On Wednesday Jerome Powell said, and didn't say, just enough to prolong a run up in risk assets into the weekly close. Why?

In short, he didn't say anything that was incrementally hawkish. Crack the window open for those itching to go long, and in the short-run, they will pile in and duly vaporize short sellers. 

As ever, we resort to charts and lines to settle the case. And in the Nasdaq, we don't yet see a decisive break above the defined down channel that has dominated this year. Best guess? Bear Market Rally. But who can say? And is there a trade worth taking in this milieu? 

This week the Consumer Price Index, the inflation measure that now governs the market, came in higher than consensus at 9.1%. And yet the 10 year treasury yield didn't move. And the equity market chopped sideways.

What do we make of this? According to the high priests of the bond market, we've priced in an even more hawkish Federal Reserve in the near term. And thereby a higher chance of a recession later on. 

In this milieu, the long bond ETF TLT might be forming a bottom. But still the game is patience.