Epsilon Theory Professional
Nothing gets my spidey-sense tingling more than a market that looks benign enough, but has enormous carnage occurring just below the surface. And that’s exactly what’s happened so far in 2023, where risk assets in general and the US stock market in particular have been strong but momentum strategies have been absolutely destroyed.
Whether or not Blackstone and Starwood are successful in maintaining the Story of Adequate Liquidity and preserving their private REIT franchises through this storm depends on one thing and one thing only – how bad is the storm going to get? If it’s a “soft landing” or a “mild recession”, then they’ll sail through this fine. But if it’s a bad recession …
Unfortunately for private REIT managers and their LPs, I think the odds of a bad recession in 2023 went up substantially this week.
I expect Wall Street and financial media to trumpet the “soft landing” thesis pretty loudly over the next few weeks. Is this correct? Personally, I don’t think so. Six months from now, will we have a soft landing or a hard landing? Personally, I think it’ll be a hard landing.
But who cares what I think!
If you are responsible for Other People’s Money, you sever ties with your undercapitalized, overlevered broker before there’s a run on the bank. You get out when you suspect, not when you know for sure. And if your friends are unhappy about that … well, tough.
This is the business we have chosen.
I believe quite strongly that Bankman-Fried should be questioned a) by professionals, b) under oath, and c) in a venue that allows for evidence to be presented, other witnesses to be called, and his testimony to be impeached.
Here’s the script for that!
A big change in our Narrative monitors this month!
Also, some shocking (to me, anyway) data on how good some companies are with their stock buybacks, and how ugly and bad other companies are with theirs.
I think it’s going to be a long winter in tech-world.
In Q4 2007 – in the aftermath of the Bear Stearns MBS funds going out (June), the blow-up across most quant funds (August), and both autos and housing rolling over in the US – I got net short in my hedge fund and started looking for single stocks with business models that were levered to borrowing short and lending long in the structured mortgage product world.
Today I’m getting the same funny feeling about the structured mortgage product world.
Everywhere you look today, you are seeing Wall Street and Washington missionaries using annualized month-over-month or quarter-over-quarter inflation statistics to “prove” their opinions that inflation is not embedded and – more importantly – their opinions that the Fed should stop hiking interest rates.
It’s a terribly flawed Cartoon of reality, but a very powerful Narrative weapon.
My rule of thumb is that it takes about two months for the dead bodies of institutional investment firms that have been drowned by some macro turn of events to float to the surface. That’s a pretty gruesome way of making my point, and apologies for that, but it’s the best and truest analogy I could think of.
The math that drives 2023 dovish hopes on Wall Street and the White House is this: string 12 months of constant +0.2% month-over-month CPI readings together, and your CPI will end up at 2.43%.
Here are 4 consequences of policy makers waiting and hoping this comes to pass.
Could the German situation get worse? Of course it could. Have we had a “Lehman moment” yet? No, we have not. But I don’t think we are that far away from a Lehman moment in Germany, after which further bets on the system breaking down become much less attractive as existential system risk grows much higher. I don’t think we are that far away from a Tepper moment in Germany, where risk/reward asymmetry becomes infinitely skewed to going long for those who are going to be wiped out if the system fails anyway.
In times of profound informational need – like today when we *really* need to know if inflation is embedded in the real economy – we are desperate for data that will allow us to act with conviction. But the nature of our macro data construction guarantees we will get less accurate results during these times where we need accuracy the most.
As the kids would say, it’s just math.
Multiple not-seen-in-a-quarter-century events have occurred over the past six weeks in rates-world. The lack of Narrative attention is striking, as are the implications for the next few quarters across markets.
I believe that it is impossible in a robust, ie, non-financialized and non-levered macroeconomic world, for a nation’s people to be a lot richer than their economy grows.
But that’s where we are.
It feels weird to be rooting for a Volcker-esque recession and long bear market as the best potential outcome for where we are today. But there are worse outcomes, like Weimar or war. And it feels like those much worse outcomes are squarely on the path of least political resistance.
We have two new Narrative signals here in June, both Bullish in direction, which is a welcome change from the largely uniform Bearish signals of April and May.
But both on the surface and beneath the surface, there is an enormous amount of conflict and churn happening in narrative-world. Time to trim the risk sails.
For a solid two years, call it early 2011 through early 2013, comparative euro-area gov’t bond yields was the first chart I’d look at in the morning and the last chart I’d look at in the evening.
Time to start doing that again.
If there’s one Common Knowledge Narrative that I think can break over the coming months, it’s But The US Consumer Is Strong! ™.
I’d like to tell you that our Narrative Monitors are not as bearish for May as they were for April.
Yep, I’d really like to tell you that.
The big global risk today is not that the banks are undercapitalized. No, the big global risk today is that banks are unwilling to provide long-term financing for anything. The big global risk today is that we are only in the early innings of a profound deleveraging cycle.
The Narrative puts and takes of March (and the resulting market rollercoaster) have coalesced into no puts and all takes. This is about as bearish a set of narrative signals for risk assets as we’ve had in a long time.
I personally thought what Powell said in his presser today was market-negative. But who cares what I think! What matters is how market participants are geared to interpret what Powell was saying, and our Narrative Machine clearly showed they would interpret it positively. No matter what he actually said.
In commodity markets, crypto markets, and equity markets … we’re all sardine traders now.
I don’t think the proposed Russia sanctions are likely to trigger a systemic financial crisis, and I think Putin’s nuclear saber-rattling is posturing for Ukrainian settlement negotiations. I really don’t see the path to a global crisis here. Famous last words, I know …