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There are a couple of tectonic plates moving in narrative-world of late, just like there have been a couple of tectonic plates moving in market-world. The market-world tectonic plates are factors like momentum and value, and lots of people are talking about them. The narrative-world tectonic plates are inflation and central banks, and that’s what I’m going to talk about.

Our most impactful structural attribute of narrative is Attention – the level of “drum-beating” for a certain narrative relative to all of the OTHER narratives taking place. It’s not just an increase or decrease in the number of articles that drives an increase or decrease in narrative Attention … it’s much more an increase or decrease in the centrality and the connectivity of the articles.

These measures of centrality and connectivity within a giant multi-dimensional data matrix don’t lend themselves to two-dimensional visualizations very well, at least not nearly as well as other attributes like Cohesion and Sentiment, so I won’t be showing those visualizations here (although you can see them in the attached data packet). But just to reiterate … I believe Attention is the most important measurement we take in the Narrative Machine.

So I think it matters that the Inflation narrative is close to all-time lows in its Attention score coming into September, while both the Central Bank narrative AND the Trade & Tariff narrative are at all-time highs in their Attention scores coming into September.

Our rule of thumb regarding Attention (and this is true whether you’re talking about single stocks or sectors or macro issues) is pretty simple: fade high Attention and accumulate low Attention.

More specifically, I’ve got the following takes from these narrative Attention scores:

• There is enormous market complacency around inflation. Just enormous.

• Markets are far more likely to be disappointed by Central Banks today than encouraged.

• The all-China-all-the-time news cycle is at a peak.

How does this play out? I dunno. If there were any signs of the US Recession narrative actually taking root in domestic US issues, then I’d say that it’s time to study up on the stagflation playbook. But as I described in last week’s letter, there’s nothing about the US in the US Recession narrative … it’s all non-US issues. Still, even if it’s not an all-out stagflationary world, we’re going to have some whiffs of that stagflationary odor. Gold? I don’t think you get hurt with all this complacency on inflation, but it’s hard for gold to work so long as Central Banks are front and center. Keep in mind that I think markets are likely to be disappointed in Central Bank action, not that they’ve lost faith in the ability of Central Banks to control market outcomes.

My best take at putting all this together? The back-up we’ve seen in rates over the past two weeks has the narrative legs to back up more. Maybe a lot more. And that’s not going to make anyone happy. Especially the guy in the White House.

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Before I get into the planned subject for this week’s note, I thought I would take a minute to describe what we’re seeing from a narrative perspective in the under-the-market-surface dislocations that have occurred over the past few days. As you’re probably aware, Value stocks (financials and energy listings, for the most part) have outperformed Growth stocks (tech listings, for the most part) to a degree that we haven’t seen in years.

None of this shows up in the specific financial sector, energy sector, and tech sector narrative data. On the contrary, the specific sector narratives are wrong-footed for these sharp shifts. This isn’t a financials story per se, or an energy story per se, or a tech story per se.

I think it’s a Value narrative in general that is playing out here (for how long is anyone’s guess), and a yield curve / negative interest rates story in particular. The “negative interest rates are inexorably coming to the US” story got a lot of play last month, as did “the ECB is going to go crazy with new policy” … both of which were terrible narratives for financials and the yield curve and value stocks in general. We’ll see what the ECB actually does on Thursday, but the narrative of the last week or two has been “well maybe we were being overly optimistic about ECB boldness” and you’ve seen the yield curve on both Bunds and USTs steepen a lot, with a commensurate move in financials and value stocks in general. The last few days have been a magnified version of that, playing out across everything that touches the “value complex”.

On a personal note – and I certainly don’t have any narrative analysis to back this up – the past few days (and the past six weeks, really) have felt like long periods of 2008 and 2009, where the only thing that mattered for markets was risk-on/risk-off, and that “factor” swamped whatever else you were doing in your investment process. This isn’t as all-pervasive as risk-on/risk-off, but whatever it is (rates-on/rates-off?), it’s as impactful in the value/growth context.

And now our regularly scheduled note.

We’re pleased to announce a sixth standing narrative Monitor – US Recession – to join our roster of Central Bank Omnipotence, Inflation, Trade & Tariffs, Credit Cycle, and US Fiscal Policy. We’ve produced historical values for the Recession Monitor through January of this year, and we can speak to the 2018 narrative patterns here.

You can see the full write-up for all six narrative Monitors here, but thought I’d speak directly to the Recession findings today.

Here’s a copy of the Recession narrative map for August.

The first thing you’ll notice is how many narrative sub-clusters there are for non-US issues … in a US Recession narrative map! Yes, most of these non-US clusters are outside of the narrative center of this map, but not all … German stimulus and ECB stimulus are at the heart of this map, and Chinese economic data is not far out from the center.

I’ve never seen a US-oriented macro query that yielded more non-US narrative clusters!

Moreover, the largest (and most central) narrative cluster has nothing to do with the real economy in the US, but is focused on the inverted yield curve and its “signal” of recession. Again, nothing to do with an actual recession in the US real economy.

Finally, as Rusty notes in the attached commentary, the cohesion of this August Recession narrative map is quite low, meaning that the sub-clusters tend to be spread apart and relatively unconnected with a common narrative theme.

Put it all together and here’s my conclusion: there is quite a lot of narrative attention being paid to the concept of a US recession … everyone is falling over themselves looking for a US recession. But it doesn’t exist. At least it doesn’t exist in the US real economy.

These recession fears should be faded.

Peter King (the sportswriter, not the Congressman) writes a football column where he makes a distinction between the things he thinks and the things he thinks he thinks. The latter being less certain in his own mind, I guess. It always struck me as a strange conceit to use as the framework for a regular column that dates back … decades … but I’m adopting it in this note to make a slightly different distinction.

I think I think that there have been two tectonic shifts in major narrative patterns over the past few weeks. I put it this way because I don’t have any strong evidence from our Narrative Machine measurements that this is the case. Not yet, anyway … these are both recent developments.  If I did, then I’d say that I think these things. As it stands, I’m telling you that my views are based on my subjective and personal narrative antennae for this stuff. I’m less certain than if I had Narrative Machine data to back it up. But I think I think this is true nonetheless.

The first tectonic shift concerns the market narrative around central banks in general and the Fed in particular. For the past decade, the “cover story” for market-supporting or financial asset-supporting monetary policy has been that it helps the real economy, too. That cover story has evaporated. More and more, I am seeing and hearing prominent media Missionaries (in the game theoretic sense of the word) question the idea that cutting interest rates from these low levels does anything for the real economy, particularly for corporate investment in productive economic activities.

To be clear, no one is saying that more and more accommodative monetary policy would be unhelpful for *markets*, so I do NOT think I think that this shift in the central bank narrative foreshadows some big down move in financial asset prices. No, no … when the Fed cuts (not if but when) two or three or four or five more times, financial asset prices will react as they always react. Oooh, that feels good! More drugs, please! But losing the cover story of accommodative monetary policy helping the real economy and the little guy has an enormous impact, I think I think, on *politics*.

Hold that thought.

The second tectonic shift that I am seeing and hearing is only a few days old. I think I think that the market narrative around Donald Trump changed dramatically last Friday, between “hereby ordered” and “enemy Powell” and those tariff numbers thrown around like confetti. I think I think that Donald Trump lost the Wall Street Journal and CNBC on Friday with his conduct of the China Trade War, in exactly the same way that Lyndon Johnson lost Walter Cronkite with his conduct of the Vietnam War, and with ultimately the same *political* effect.

I think I think that the financial media has been the strongest media force for the normalization of Trump, as the near-universal subtext (if not overt text) of financial media Missionaries has been “I don’t like his style, but he’s done some good things.” Like a stock market that’s gone up, up, up since his election. Like tax cuts. That normalization narrative stopped on a dime last Friday, and has been replaced by a narrative that Donald Trump IS “macro risk”.

Putting these two tectonic narrative shifts together, I think I think we are rapidly approaching a moment of political nihilism, where NOTHING is believed on its merits and ALL of our pleasant fictions that support cooperative gameplay in our domestic political institutions are dashed.

Again, I do NOT think I think that all this puts us on the cusp of some market breakdown, as the narrative of “the Fed has got the market’s back” is still going strong. But I DO think I think that the widening gyre of American politics is now poised to “take another leg down”, as we’d say in a market context. How that manifests itself … I don’t know. But I think I think it’s coming.

I learned the distinction between excuses and reasons when I was 12 years old and had failed to do some sort of chore at home. As my father told me before grounding me, “Ben, you have lots of good excuses, but no good reasons.”

So I’m late with this week’s ET Pro email, and my excuse is that I was up in the wilds of Maine from last Thursday through Monday for a Team Elite fishing camp experience that David Kotok graciously hosts every year. Internet connectivity was pretty non-existent, the fish were biting … yada, yada, yada.

But I also have a *reason* for being late with the email this week. The news about Jeffrey Epstein’s death on Saturday hit me hard, as did the escalation in the Hong Kong protests over the weekend, as did the collapse in Argentina’s currency and stock market on Monday. As the kids would say, I was shook. And I’m still trying to figure out what I think about all this, both as a citizen and as an investor.

Of the three events, I’m most settled in my views on Epstein. I think it’s possible to be outraged (beyond outraged, really) at his death without succumbing to any conspiracy theory at all, much less the way out-there theories, and that’s what I’ve tried to capture in “I’m a Superstitious Man”, published yesterday on the website and attached as a PDF here. It’s a feeling that I haven’t experienced since October 2008, when the US Treasury put the full faith and credit of the United States behind the unsecured debt of Goldman Sachs, Morgan Stanley, JP Morgan and Bank of America … a feeling that the pleasant skin of American democracy has been peeled away to reveal the naked sinews of power, wealth and violence beneath. Does anything about the Epstein case impact markets and investing? Nah. Not so far as I can see, anyway. But this was the event that shook me the most.

I’m still not settled on my views on Hong Kong, but Rusty made a big contribution in helping me frame those views with a wonderful note he published yesterday, “Does It Make a Sound?”. The answer to that question – what is the Hong Kong Resistance narrative in the US mainstream media? – is pretty resounding: it does not exist. Rusty presents the empirical evidence from the Narrative Machine. As we like to say (cribbing the old George Soros line), we’re observing, not predicting. What I’m wrestling with now is the WHY … why is the HK Resistance narrative so muted in American media? Is it a conscious effort by status quo elites to downplay what’s happening? Is it a structural element of a domestic widening gyre? I’m still wrestling.

If any HK-resident ET Pro subscribers (of which there are several) are able to share their thoughts, I’d be grateful to hear them. Your privacy and anonymity are my greatest concern, and unless you explicitly tell me otherwise, NOTHING you email will be shared with ANYONE.

I’m also not settled on my views on Argentina specifically and EM more generally, other than what I’ve been saying for a while now … with the exception of China and its insulated domestic currency, EM monetary policy is just a shadow of DM monetary policy.

Macri embraced that shadowy semi-sovereign existence, as it allowed the IMF support package of all IMF support packages. Foreign investors (and local oligarchs) rejoiced, of course, as the cornerstone of any IMF support package is preserving the property rights of those foreign investors. Now Fernandez and Kirchner want to break that shadow existence and chart a (much) more independent monetary policy path, which means that the IMF support package and its associated property right protections for foreign investors will evaporate like a winter rain on the pampas. Good times.

Is Argentina an idiosyncratic outcome for EM investors, or is Argentina indicative of a structural risk for EM investors? Yes. Not trying to be flippant with that answer, but in truth that is the answer. If you’re thinking about EM as a thing – as a discrete asset class – then this is absolutely indicative of a structural risk. It’s a manifestation of what I think is the category error you’ve made in thinking about EM as a thing. If you’re not thinking about EM as a thing, then this is absolutely an idiosyncratic outcome. But it’s also an idiosyncratic outcome that can easily be duplicated in a lot of countries … so maybe not so idiosyncratic after all. Either way, I don’t think there is any more difficult job in finance today than being an EM investor. And it’s not going to get easier.

Two last points to call your attention to before closing this belated email.

First, if you haven’t reviewed the ET Pro Monitors, they were updated earlier this month and I’ve attached that PDF here. Frankly, no big breaks or changes in the macro narrative structures we measure, but we’re watching the Central Bank Omnipotence narrative carefully for any signs of it being replaced by a coherent “central banks are impotent” counter-narrative.

Second, we recently put out an In Focus piece for ET Pro subscribers with our analysis of “Big Tech Anti-Trust Narratives: Deteriorating but Disconnected”. The skinny here is that while we think this could be a powerful thematic short, you’re VERY early from a narrative perspective if you’re acting on this now.

Last October I wrote “Things Fall Apart (Part 3) – Markets”, focused on the three big deflationary shocks that could hit markets, and the one big inflationary shock that would ride in on a pale horse after the deflationary shocks had their way with us.

The Three Horsemen of the Investing Semi-Apocalypse

• The Fed keeps on raising interest rates and shrinking its balance sheet, ultimately causing a nasty recession in the US and an outright depression in emerging markets.

• China drops a trade war atom bomb by letting the yuan devalue sharply, sparking a global credit freeze that makes the 1997 Asian crisis look like a mild autumn day.

• Italy and its populist government play hardball with Germany and the ECB in a way that Greece could not, leading to a Euro crisis that dwarfs the 2012 crisis.

Markets suffered through the deflationary shock of the First Horseman in Q4 of last year, but then recovered nicely after Jay Powell’s monetary policy independence was taken out into the street and shot in the head on Christmas Eve.

Markets are now suffering through the Second Horseman riding into town, as China “surprised” markets with a sharp devaluation of the yuan last night in response to higher/broader tariffs that Trump threatened to impose last week.

Here are the questions Rusty and I are asking now, along with our answers …

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Could the tit-for-tat of a trade war escalation into a currency war and a global credit freeze result in as painful a market decline as Q4 last year?

Absolutely.

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Will the Second Horseman ultimately be vanquished like the First Horseman?

I very much think so. I can’t tell you which equilibrium in a game of Chicken will prevail, but there will be an equilibrium reached, probably one where both China and the US declare victory domestically.

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When will the Second Horseman be vanquished?

No idea. It’s a core ET precept, taking from an old George Soros line … we’re observing, not predicting.

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How will we know if we’re wrong, and the Second Horseman is here to stay?

Two ways: a) if the Trump administration turns the trade/currency narrative into a full-blown national security narrative (i.e., this is a new “Cold War” against a new “Evil Empire”), or b) if common knowledge around the Central Bank Omnipotence narrative weakens dramatically (i.e., the Fed and ECB are “powerless” to do anything about the ongoing deflationary shock).

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So that’s what we’re going to be watching closely – any shift in the Trade & Tariff narrative towards a national security narrative, and any shift in the Central Bank Omnipotence narrative towards an impotence narrative – and that’s what we’ll be reporting back to you.

In real-world, as opposed to narrative-world, I think you should be looking for signs of a credit freeze in trade finance to get a sense of how bad this trade/currency war can get.

As in 1997 (and to a lesser extent 2015), this is a credit freeze that will start in Asia and then spread globally. It will be levered to trade finance, but will hit ANY sector or subsector where the narrative is based on trade and growth. In other words, EM currencies and markets get absolutely gob-smacked, DM rates continue to plumb uncharted depths in the negative-rates abyss, and financials have no support.

It’s that last piece – shorting non-obvious financials that have secondary exposure to trade finance woes, at least in narrative-world – where I think there’s a trade that hasn’t already been priced in after the last few days. For me, that go-to trade is buying CDS protection on the iTraxx Senior European Financial index, a trade I’ve written about before for ET Professional subscribers, as recently as this May (“In the Flow – Chef’s Knives”).

Here’s the one year chart for the SNRFIN, wider by 5 bps today but only in the low 70s …

And the five year chart …

If the yuan devaluation sparks a credit freeze in global trade finance, which I think is more likely than not, then we could see these spreads widen to 120 bps in very short order, which would be … something. The next ECB policy meeting isn’t until Sept 12, so unless Mario and Christine start jawboning pretty hard and pretty fast from wherever they are vacationing, I don’t see how the blisteringly negative narrative around European financials changes course for the next four weeks.

Like I say, this is a trade and not an investment, and a CDS contract is a chef’s knife – they’re sharp and you need to know what you’re doing. But these are exchange-traded instruments and can be an effective tool in any professional investor’s kitchen.

Yours in service to the Pack,

Ben

The dog that didn’t bark is the punchline to a famous Sherlock Holmes story, Silver Blaze, where our man Sherl deduces that the killer was a familiar presence at the murder scene because of the absence of a clue – the watchdog who barked not at all as the murderer came and went.

It’s the same thing with US fiscal policy … it’s the absence of a clue that tells me the market is extremely complacent about what is coming down the pike here.

That clue is, of course, the market narrative, and when I say that a market narrative is absent from US Fiscal Policy, I mean that there is no connection between the occasional financial media article about budget votes or fiscal policy and ANYTHING written about markets per se. This was the point of an ET Zeitgeist note I published last Friday, titled We’re All MMT’ers Now. It’s a quick read and worth your time.

In this email, I want to show you the Narrative Monitor we maintain on US Fiscal Policy so that you can understand why we think this is a big deal.

Here’s the page on the ET Professional site where you can access this Monitor data, and here’s what Rusty had to say about our results:

• As in prior months, there is very little attention being paid to fiscal policy/budgetary topics, and practically no linguistic connection between them and financial markets narratives.
• Cohesion and Fiat News, too, remain at floor levels.
• We counsel some awareness of the scale of policy proposals, especially those being promoted by leading Democratic candidates. The market is paying zero attention with zero cohesion, which we observe as a complacent structure.
• A sufficiently credible candidate with a GND/MMT-style approach could be a significant surprise to a market that could not care less about debt ceiling negotiations, government shutdowns, debt levels or budget deficits.

And here’s the narrative map itself:

What Rusty is focused on is the peripheral position of market-related narrative clusters (what’s moving the US market, why are China stocks rallying/falling, etc.) all found at the top of the narrative map, and the distance and empty space between these clusters and the center of the narrative – the record US budget deficit – as well as the distance and empty space between these clusters and the bottom of the narrative map – the fiscal policies proposed by Democratic candidates.

Up/down/left/right means nothing in these narrative maps. You can turn them 90 degrees or upside-down and nothing changes in their meaning. What is meaningful is centrality and distance and the connective links between clusters.

When Rusty and I see a narrative map like this, we immediately look at the narrative core of anything written about US fiscal policy – the record deficit shown as a bright red cluster – and how linguistically divorced those articles are from ALL other articles that show up when you do a search on “fiscal policy”. None of these peripheral articles are really about fiscal policy. They use that phrase in the article, but the article is about something else.

We also see that the articles about markets are as far apart from articles on Democratic candidate policies, like student debt forgiveness, as it is possible to be on this map. In other words, even though all of these articles share the phrase “fiscal policy” somewhere in their text, there is ZERO linguistic connection between an article about markets and an article about what a Democratic president would do about student debt. THAT is what we mean by a complacent narrative structure.

Will the market go up or down as it becomes less complacent over fiscal policies over time? Yes. And I’m not trying to be cute with that answer.

I don’t know what the market reaction will be as (or if) fiscal policies and proposals become biting (or pleasing) realities. All I know is that the market is unprepared for this. All I know is that fiscal policy is NOT in the price of financial assets today.

Yours in service to the Pack,

Ben

Yesterday I published a brief note called “I’m Not a Raccoon! I’m the Lone Ranger!” about the hucksters and the con men in the crypto space. The point was that the obvious frauds reveal themselves pretty easily, but there are less obvious – yet no less fraudulent –narratives for Bitcoin being made by prominent people who live at the intersection of Wall Street and Bitcoin. These are people who should (and I think do) know better, but promote these false narratives anyway because it makes them money.

I’m Not a Raccoon! I’m the Lone Ranger!

The false narrative I was referring to specifically in that note was the idea that ‘network effects’ or Metcalfe’s Law or some other description of transaction volumes was a source of intrinsic value in Bitcoin. This is nonsense. There are no ‘network effects’ for a non-cash-flowing, non-productive thing. There is no ‘tipping-point’ in the transactional network around a non-cash-flowing, non-productive thing beyond which it becomes ‘too big to fail’ or becomes ‘an accepted store of value’.

Are there non-fraudulent arguments for buying-and-holding Bitcoin? Sure! There’s an inflation hedge / fiat debasement argument. There’s a security / privacy argument. There’s a fashion / expression of identity argument. But my raccoon-radar starts beeping like crazy whenever I hear someone make a network effects argument for buying-and-holding anything, much less a non-cash-flowing, non-productive thing.

I had the same raccoon-radar reaction yesterday to the FT article by Rick Rieder (Blackrock’s global fixed income CIO) and the CNBC appearance by Larry Fink in support of that article: “ECB can boost growth across Europe by buying stocks”.

The money quote:

“Lowering the cost of equity would stimulate growth through organic channels of investment, including research and development, which can provide durable economic gains.”

LOL.

I mean … I like to think of myself as something of a connoisseur of trickle-down economic arguments. I get the joke. But this is INSANE. The ECB is going to spur growth in the real economy because publicly traded corporations are going to spend more on R&D if their stock price goes up? WHAT?

I’ve met Rieder and Fink a couple of times, but I don’t know them. At all. Maybe they’re decent guys. Maybe they really believe in their heart of hearts that this is wise public policy. I truly don’t know.

But if it talks like a raccoon and walks like a raccoon …

As long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Chuck Prince made his infamous get-up-and-dance quote to the FT in reference to Citi’s levered loans business, although it was later taken to refer to subprime lending. No matter, it’s the perfect quote for any age and any asset class where institutions intentionally take risks they know are foolish, but risks they believe are manageable because there’s a greater fool looking to get on the dance floor after them.

The greater fool theory is the driving force behind the bid for negative-yielding debt, whether it’s European government bonds or European investment grade corporate debt.

Sure, it would seem that I’m the fool for paying the German government 25 bps per year for the privilege of giving them my capital for ten years, but if there’s someone down the road willing to pay me a nice premium over what I paid for this Bund because the 10-year rate is now -35 bps … well, take my money now, Ms. Merkel!

The rationale for buying negative-yielding debt securities is capital appreciation and gain-on-sale, not (obviously enough) the expected return of the coupon as the security is held to maturity. In other words, the get-up-and-dance game is always a return ON capital game, not a return OF capital game.

But playing for capital appreciation in a (supposedly) risk-free rates portfolio or an IG debt portfolio is a VERY different game than playing for capital appreciation in an equity portfolio or a distressed debt portfolio.

Who is managing these negative-yielding IG and rates portfolios? The same portfolio manager who has made a career out of honing a hold-to-maturity mentality? Or did they parachute a distressed guy into this world of macro carry trades and monetary policy analysis? Either way, it’s a prescription for massive error. Either way, it’s the management of the now $13+ trillion in negative-yielding debt securities that I think is the catalyst for a blow-up here.

Let’s leave aside the distressed guy parachuting in to manage this portfolio. Because that’s not what’s going on. What’s going on is that there are a lot of hold-to-maturity IG and rates guys who now fancy themselves as momo traders. I mean … that’s not really how they think of themselves. They think of themselves exactly as Chuck Prince thought of himself – the true heir to Sandy Weill, master of the deal and the pivot, a man who knew how to hoof it – when really he was just another lawyer who couldn’t dance to save his life.

Bull markets make everyone think they’re a freakin’ genius. While bear markets doth make cowards of us all. And that last part is the problem.

In my experience, hold-to-maturity guys – and here I’m talking about both hold-to-maturity bond guys and their equivalent in equity-world, the put-it-in-a-drawer-and-never-sell-a-share guys – always get two things wrong when they decide to play the get-up-and-dance game.

1. They vastly overestimate the liquidity in their market, and they are paralyzed by the absence of bids when the shit hits the fan.
2. Their sell-discipline muscles have atrophied (if they ever existed), so they hang on waaay too long before making the first sale, and then they panic and puke out the rest into an illiquid market.

This is why I think the negative-yielding bond bubble ends in tears.

Not because bond managers are wrong about the intentions of central bankers and the direction of monetary policy for the foreseeable future. But because they overestimate their ability to trade this portfolio and they underestimate the mad rush off the dance floor when nobody sees a greater fool waiting in the wings.

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