Epsilon Theory Professional
I am increasingly thinking that both a Covid-recovery world AND a perma-Covid world are inflationary worlds, the former from a demand shock and the latter from a supply shock to the biggest and most important single asset market in the world – the US housing market.
For the past 20+ years, the real-world model for economists to understand unexpected deflation was Japan.
If the risk today is unexpected inflation, what’s the real-world model for that?
No one thinks their Super Bowl commercial is a dud going into the game, but only one or two will come out as the commercial that everyone knows that everyone knows was really special and witty and effective.
It’s the same with Wall Street narratives.
The South African variant virus (501.V2) is not nearly the immediate threat to the United States as the UK variant virus (B117). But 501.V2 has the potential to create a far more powerful narrative – vaccine resistance – that can have a greater market impact than the more pressing issues of B117.
More and more, I think the variant viruses create a tradeable event for markets,
If B117 becomes the dominant SARS-CoV-2 strain in the United States, that is a profoundly deflationary, risk-off, dollar higher, flight to safety event.
I don’t believe that ANY of this is priced into markets.
I believe there is a non-trivial chance that the United States will experience a rolling series of “Ireland events” over the next 30-45 days, where the Covid effective reproductive number (Re not R0) reaches a value between 2.4 and 3.0 in states and regions where a) the more infectious UK-variant (or similar) Covid strain has been introduced, and b) Covid fatigue has led to deterioration in social distancing behaviors.
Right now, Wall Street is trying to identify which inflation narrative will be an investment thesis that makes lots of people nod their heads.
Recognizing THAT – and maybe even trying to get ahead of THAT – is how you play the game of markets successfully.
This weekend’s regulatory news on Bitcoin is a big step forward in creating “flow” in the form of a highly liquid, easily transacted financial product that Wall Street can administer. But it’s a death knell for any “revolutionary” application for Bitcoin, as it becomes just another highly regulated game in the Wall Street casino.
We are seeing language in both the Central Bank and Security Analysis narrative regimes that would have been unthinkable even a few months ago, language that is market-negative. It’s not enough to change the market-positive narrative regimes in place today, but it’s definitely enough to make my risk antennae start to tingle.
Wall Street is redefining Bitcoin to be an Inflation Hedge™ product.
This is how Wall Street creates flow. This is how Wall Street makes money. All that stands in the way is the unregulated nature of Bitcoin. So that’s gonna change.
Three times in my professional life as an investor, I have felt a trade in my bones, by which I mean a certainty that there is a massive disjuncture between a real world poised for sharp secular decline and a market world at buoyant narrative highs. The first time was in the summer of 2008. The second time was in February of 2020. The third time is today.
In the summer of 2008 and February of 2020 I saw the trade to, yes, make money from those real world calamities. I do NOT see the trade here.
The insight of Schrödinger’s Cat is that the cat is alive AND the cat is dead before the box is opened. It’s not merely unknown whether the cat is alive or dead. The cat is actually alive AND actually dead at the same time.
In our real-life world of investing in markets, we frequently deal with real-life cats that are both alive AND dead at the same time. Like US Treasuries.
Every once in a very rare while, we see what we call a Missionary statement (an action or a speech by a famous person or organization on a ubiquitous media platform) that has the potential to change the Common Knowledge (what everyone believes that everyone believes) about an important aspect of our investment lives.
Here’s one.
We are only given the world once. Usually that’s not a big deal from an investing standpoint, because the possible parallel universes aren’t that far apart in their market consequences. Over the next three weeks (and maybe longer than that!), the fact that we are only given the world once is a very big deal indeed.
Markets happen at the margins. So does narrative impact on the market.
That’s important for understanding our semi-bearish narrative monitor signals here in October, as well as for understanding why they may not matter very much right now.
This Friday’s jobs report could show a wage inflation “shock” as salaried Americans work fewer hours to help out their kids with a shattered school schedule.
Maybe it will end up being nothing, but there are plenty of algos that trade these releases immediately as they are reported, and this is classic example of how an algo can get really wrongfooted when the underlying ultra-stable data series goes haywire. Forewarned is forearmed.