Stocks are looking forward to a double dose of joy from strong tech earnings and the Fed close to end of the tightening phase, but these may be Potemkin Markets, foundations in the sand and little behind the façade.
Whatever the US Federal Reserve does to US rates this week, the market will remain divided about what it ultimately means. What they do and say after this week’s FOMC meeting will then become the next critical thing. The market is expecting the Fed to then hold or maybe one more hike – but it depends on the data.
The markets are currently split into two camps:
· Reasons to be cheerful: an increasing number of people are convinced slowing US inflation and the economy’s resilience means the Fed has achieved the improbable holy grail of central banking – a soft landing. That’s got to be good news for stocks, maybe.
· Reasons to be fearful: Others are delving deeply into the detail of rising credit card defaults, earnings problems, a property bust, and global slowdown (particularly in China and Europe) proof of how unsustainable the current market is.
As we all know the market can remain irrational longer than holdouts against the narrative can remain solvent.
I was listening to a well known market guru describe his current strategy as: “Tactically, risk on. Strategically cautious.” Not entirely sure how you do that (short-term bonds and liquid stocks) but I guess it’s all about to trying to time the next top to sell liquid stocks, and then wait for the next bottom to re-engage. That’s the kind of irrational behaviour that entraps investors – they miss the bottom and then wait for the market to go their way before they try to play catch up, finally getting sucked in just as it tops. Remember, markets are driven by envy – the force which ‘forces’ late investors into tottering upside on the basis of FOMO.
I’m intrigued by the other analysts also looking at markets with a sense of disbelief. They point to multiple reasons its unsustainable. Some say the market still hasn’t figured how rising rates and QT replacing QE (i.e. central banks pulling cash from the market) has removed much of the free cash that was swilling around fuelling market upside, thus rendering the current multiples unsustainable. Others speak about bubbles in new tech and the mismatch between consumer disposable incomes and earnings expectations.
Apparently, the Bank of America survey says 60% of investors are bearish on stocks – which is not reflected in current markets!
Let’s try to figure it out by looking at the positive and negatives we’re currently seeing.
Reasons to be positive about include:
· Economic resilience – consumers continue to consume and the market has new drivers like digitalisation and AI driving investment themes.
· Bond rates are close to top
· Dovish Fed – many commentators predict the Fed will swing behind a looser tone.
· Russia interests becoming more isolated from those of the Global South re-establishing global geopolitical harmony as links between the West and South are reforged
· ECB likely to continue hiking, accelerating dollar weakness
· Global Investors still awash with cash
Reasons to remain negative include:
· Global investors fear global recession – look at China and European PMIs.
· Debt – Unsustainable consumer, corporate and sovereign debt
· Sticky inflation – inflation certainly isn’t beat yet
· Potential global food inflation from closed Odessa grain exports
· Saudi oil production cuts are having an impact, oil upside will be inflationary
· Hawkish Fed – the Fed may remain uber-cautious and remain on tightening mode
· Commercial Real Estate crisis
· Regional Banking crisis revisited
· Bank of Japan set to change the dynamic and hike rates
· Rising political risks in USA, UK and Europe
· Rising inequality risks
· Elevated no-see-um risk (and because they are no-see-ums I simply can’t explain why the risks are rising).
So, what is the right strategy for the moment? I can’t think we are in a Potemkin market – where the actual supports are nothing like as real as we think they are. It all looks rather rosy, but behind the false façade a whole series of issues are still to be revealed and not all of them will be positive.