Week ended January 21st, 2022
“Today in the U.S. we are in the fourth superbubble of the last hundred years.
Previous equity superbubbles had a series of distinct features that individually are rare and collectively are unique to these events. In each case, these shared characteristics have already occurred in this cycle. The checklist for a superbubble running through its phases is now complete and the wild rumpus can begin at any time.” – Jeremy Grantham, GMO
Yikes – that quote from Jeremy Grantham is frightening given the first few weeks of 2022. I don’t entirely agree with Mr Grantham though, for reasons I will discuss towards the end of this update. Still yet, this was the third week running of increasingly poor performance for equities, especially in the US, and for risk assets more broadly.
The holiday-shortened trading week in the US had (near) bookend tech influences, with the final result looking not dissimilar to the first two weeks of the year, only worse as selling pressure intensified and broadened. The week started with the announcement of MSFT’s $68 bln all-cash offer for beleaguered ATVI, and the week ended with disappointing subscriber growth numbers from NFLX after the bell on Thursday which pushed NFLX shares down 21.8% on Friday. The NFLX news was preceded by rumours Thursday during the trading day, more or less confirmed by the company, that PTON was cutting costs and reducing or halting manufacturing its gear, another blow for the so-called high-flyers that are being abandoned en masse. Even though PTON shares recovered some of their losses on Friday, they were down over 15% W-o-W.
I could go on and on about specific names, but let’s first look at some macro-economic data from the past week. December CPI was released for the UK mid-week, which came in at 5.4% (see ONS release here), the highest CPI in the UK in nearly 30 years. The reality is that stubborn inflation has arrived in force in major developed economies, although it most certainly by now must be incorporated into equity pricing (along with the pending tightening that is on the way in most countries). To a certain extent, I feel the same way about the omicron variant of COVID, as cases begin to wane, and this too feels like yesterday’s news. I will discuss USTs further below. Yields on the 10-year Japanese government bond (“JGB”) closed at 0.13% Friday, testing the Bank of Japan’s resolve to manage the 10-year yield to 0%. The yield on the 10y JGB has rarely been above 0.10% in the last five years, so this breech will be viewed as a test for the Bank of Japan to see if they stick to yield curve management in the face of an “inflationary hangover” related to pandemic-period stimulus. Even as yields headed higher in developed economies, the world’s second largest economy seems to be moving the other way. China’s central bank is turning more dovish to contain the collateral damage from the slow collapse of Evergrande, lowering its 1- and 5-year prime rates last week. The looming shake-out in the Chinese property market will probably not be pretty, but this has to be digested in the context of significantly lower valuations on most Chinese stocks.
Looking at this news in the aggregate – and adding in geopolitical uncertainty associated with Ukraine – equities again had a tumultuous week, as higher yields early in the week undermined investor confidence and torpedoed technology stocks. As yields head higher on shorter-dated government bonds, investors are arguably showing central banks the way, anticipating their pending moves (upwards) in over-night borrowing rates to tame inflation. This, in turn, is causing great consternation in global stock markets, with the most vulnerable companies being those that had ascended to nose-bleed valuations during the pandemic-recovery. I’m not sure I see an easy end to this, although I do expect earnings to eventually provide some support. I would also not be surprised to see equities overshoot on the downside if the same momentum buyers that pushed stocks higher since the pandemic start to panic and run for the exit doors. Let me go one step further, acknowledging in advance that this is not the current market narrative since inflation is at the forefront of investors’ minds. I could imagine a scenario in which the sell-off in risk assets buffer price declines in intermediate and long-term government bonds as equity investors shift assets into the safety of US Treasuries, at least temporarily until equity markets stabilise. This is not my base assumption, and I am not positioned for this to occur personally, but such a migration could happen. There seems to be a growing number of economists suggesting that the Fed will be proven right after all at the end of the day as inflationary pressures moderate as the year wears on. There is also the possibility, as slim as it may seem at the moment, of the “Fed put” coming into play, meaning that the Fed would slow its hawkish monetary tilt should risk assets continue to tumble. The elevated level of oil prices also cannot be ignored. Higher oil prices juice immediate inflation, but also will eventually serve as a drag on economic activity should prices remain elevated.
There is plenty of news to write about this week, but I will stop here and turn to the rather depressing performance of the financial markets this past week.
As you have probably gathered by now, there were few if any places to hide this past week as far as global equities. The Shanghai Composite was flat on the week, which is the best that was on offer, whilst the S&P 500 had the worst performance of the indices I track, off 5.5%. The FTSE 100 has provided the best return year-to-date (+1.5%), benefitting most certainly from the heavy energy weighting in the index (WTI crude +12.5% YtD), whilst the MSCI EM (emerging markets index) has also been slightly positive.
US equities were hammered this week, but it was not across-the-board.
Rather, it was the “expensive” stocks that took most of the beating, including the infamous (and generally unprofitable) high-flyers of yesterday. I wrote about ARK ETFs, an excellent proxy for high- flyers, mid-week in an article you can find here, if you can bear to read it: “ARK Invest Update”. But it was not only the smaller, unprofitable momentum stocks that got crushed, as more established, profitable (albeit arguably still expensive) companies – including SHOP (-20% W-o-W), AMZN (-12% W-o-W) and NVDA (-13% W-o-W) – were also caught in the intensifying downdraft. So far, most defensive stocks have held up much better, but it might only be a matter of time before “the baby gets thrown out with the bathwater” and there is complete capitulation across the board. In the meantime, make sure you are mentally prepared to review your month-end pension statement or 401(k) as January nears its end, because if things continue like this, you will not be happy! Still yet, my mantra is that earnings this round (although retrospective since 4Q) should be supportive for large, profitable companies. And I would go further and even say that the high-flyers will get oversold at some point on the downside. As far as overall risk in the US markets, the VIX closed Friday at its highest level (29.4) since early December, a level that is concerning as we look forward.
US Treasuries were volatile this past week, too. Yields spiked early in the week because of ongoing inflationary concerns, then stabilised and fell as the week wore on, as investors sought the safety of US Treasury bonds. Still, the damage was done early in the week with higher yields continuing to wreck technology stocks, with high-flyers being the most affected. It will be interesting to see how the Federal Reserve behaves should the market for risk assets continue to deteriorate. I would not be surprised to see some sort of capitulation if this carries on, because the Powell-led Fed has reversed course before (late 2018) when equities were heading into the toilet. It’s not the Fed’s role and it shouldn’t happen, but it very well could.
As far as other safe haven assets, gold was firm again this week, closing at $1,834.55/ounce, +1% W-o-W, as investors sought safety. The US Dollar also not surprisingly strengthened as market risk overall increased, and investors migrated to safety.
As far as other assets, oil was higher most of the week before falling on Friday, but still ended the week 1% higher on the week. The carnage in cryptocurrencies also continued and intensified, making equity volatility look like a walk in the park. Bitcoin, the recognised crypto benchmark, was at $36,086 at the time I am writing this on Friday evening, down 16.5% W-o-W. That’s some store of value! Is this a rough patch or is it further capitulation in an asset class that moves solely on supply and demand, with no intrinsic way to say if BTC is worth $1 or $100,000…..or at least no valuation method I understand. Crypto prices seem to move on pure momentum, and it is surprising at times how quickly investors can forget that this cuts both ways.
I am not sure what to expect for next week. The higher volatility / momentum markets like the NASDAQ are into correction territory, with the index down 11.8% YtD and 14.3% off its high of November 18th 2021. The Russell 2000 is down 11% YtD and 18.6% off its high of November 8th 2021, so smaller cap names are selling off in spite of the fact that the index is considered a value play. However, the S&P 500 is only 8.3% off its early January (2022) high, and some professional investors are calling for a much more extensive correction in the benchmark index that will not leave any stocks behind. I started the update with a quote from Jeremy Grantham of GMO, and if you can tolerate it, the full article by Mr Grantham is here: “Let the Wild Rumpus Begin”. I buy his comments on being in a bubble, probably not surprising to my readers that follow E-MorningCoffee. But I do not agree with Mr Grantham that there will be an indiscriminate correction (although there could be more to come), because not all stocks are wildly over-valued, and I also don’t agree with his severe expectations regarding retracement. Give it a read and see what you think.