The Week That Was (Jan 31-Feb 4, 2022)

He who has not the spirit of his time, has all the misery of it: Voltaire

An inconvenient truth: the flat yield curve

This newsletter made the case last week that certain areas of the market were oversold and VXN, the volatility index for Nasdaq 100, was peaking. Other indicators looked to be at extreme levels too. The AAII US investor sentiment bullish readings hit a low and the put/call ratio reached highs.

It would be a mistake to think volatility is behind us though. This year promises to be like other years when the Fed is in hiking mode. Think 2010. Think 2018. Markets will go up and down, potentially violently, during the 1H, as it worries about whether Powell will make a policy mistake.

It seems Powell is being cautious. There has been signs of tightening but it still seems to be on a relatively modest scale. High yield spreads are wider but only by a bit. CCC spreads are way below the historical average of 12%. The street, nevertheless, is continuing to ratchet up their expectations for Fed hikes but perhaps it should curb its enthusiasm a little.

Irving Fischer, a peer of Keynes, noted the bond yield curve was a function of growth and inflation expectations. The Fed puts this theory up there with the Phillip’s Curve. But if they are a believer, then the current bond yield curve presents a problem.

It’s flat. That means the bond market doesn’t really believe there will be either growth or inflation.

Should we worry? A little. There have been plenty of times in the past when the FED has ignored the bond market to the detriment of the economy. In 1950, CPI increased rapidly like today. Back then people panicked about rationing that would be brought on by the Korean War. There was panic buying of toilet paper, very much like the panic buying that took place in Australia during Covid. The FED used the incident as a reason to become independent. It needed to act. The bond market hardly budged and CPI quickly normalized in spite of the Fed’s burst of activity. Greenspan and Bernanke both didn’t pay enough respect to the bond market either at crucial moments.

Powell will, I’m sure, do one rate hike in March (some are saying 50 bps!) but can he really keep going? Time will tell. It’s unclear the new paradigm can handle “normal rates.” Powell has only made one mistake and that was in the fall of 2018 when he raised again despite signs he shouldn’t. He got a lot of criticism for that. Otherwise, he has been pretty good as Fed Chair, navigating the Corona crisis much better than perhaps Greenspan would have.

My guess is he is paying a lot of attention to that bond yield curve. A higher stock market and higher real estate prices are an important part of the Keynesian feel good effect! And one must remember the Fed and the Treasury are Keynesians. Why does he want to unwind all his good work by being too hawkish? And wasn’t it only a matter of a few weeks ago that he was saying it was all transitory anyway.

This is NOT the 1970s

This newsletter has made the case that today is nothing like the 1970s and that the stagflation thesis lacks substance. The inflation we are seeing is not the continuous and sustainable increase in prices that started as early as 1965 and caused such pain in the 1970s. There were also not so many growth drivers back then.

Arthur Okun was an American economist, who spent a lot of time looking at the relationship between growth and unemployment. He also famously created The Misery Index. The basic premise of the index is if you don’t have a job and you have to deal with rising costs, life sucks! You are miserable.

What’s interesting if you look at the chart is how high it was in the 1970s compared to now. The current level is close to where it was in 2008 and 2012. It’s easy to forget with all the bears out there preaching the end of the world that we are at full unemployment with millions of job openings and, for the first time in 30 years, the low end worker has some wage power. That’s huge!

All in all, today is a million times better than the 1970s. We just don’t have Hot Chocolate in the charts anymore.

The Upwardly Mobile 20-Something Ballers

One interesting dynamic that gets little attention but also marks a major difference from the 1970s relates to the growing wealth amongst 20-somethings. It’s surprising no one has come up with a term like “yuppie” to describe the cohort. A documentary about life on Puerto Rico for the crypto nomads is surely warranted, if to show that nothing really changes. Young people, with a bit of money in their pocket, will behave badly. It would appear that tech geeks like models and bottles just as much as their investment bank counterparts from yesteryear.

The impact of crypto/defi on wealth creation has been insane and the stories of 100x returns still blow my mind — I miss out on a lot of opportunities as I am old and clearly not a baller. The point, though, is we still don’t know how this will play out. Young people with so much wealth is an interesting phenomenon, albeit they are a small cadre currently. What impact will it have on society, politics and the economy?

My gut feel is it will be largely positive. Yes, there are clearly excesses but the 20 something cohort are, if you can get passed some of the excessive political correctness, better than my cohort were and definitely better than the equivalent age group in the 1970s (I know that’s controversial).

They are well educated, even though not always formally. The impact of the internet and, dare I say it, social media, has been considerable on people’s general knowledge. They are obviously more technological. They are more entrepreneurial. But perhaps, most important, they are much more open (read less racist/inward looking) and generally more optimistic.

The 1970s had punks and God Save the Queen. Today we have a dull ginger haired crooner, who could be this generation’s Frank Sinatra, and Satoshi Nakamura. Reason to be positive?

Understanding the energy of this cohort is more important in determining the spirit of the time, as Voltaire describes, than paying attention to the boomers, in my opinion. A lot of amazing things could be about to happen. And none of them will be started by the boomers.

High nominal growth and inflation = higher stocks…..eventually

Yes, inflation is currently high, but we are also seeing huge growth (7.9%). The big question for me is what will happen to inflation. I’m confident there will be growth. But by the end of the year, one wonders whether we will see more charts like the Baltic Exchange Dry Index, which has had a big drop of late:

I personally think so. And it’s part of the reason why I believe this is just a blip in a long term bull market. I also believe it’s ludicrous to believe a Fed at 1% means the end of stocks. Stocks tend to do well when inflation and nominal GDP growth is high. Look at the 1980s. Think higher corporate revenue. Think higher incomes. Think easier debt paybacks.

People also become wealthier. And that means more stock buying, especially when there really aren’t that many other assets to buy if you have some extra shrapnel in your pocket.

For instance, compare today with 2012. In 2012, you could invest in a mobile home park passively in the US and get a double digit return. Today, that’s just not possible. Real asset prices have gone up too much. It’s the same for private debt like first mortgages. So much money in the system has driven down yields for first mortgages from 9–10% in 2012 to sub 5% in Southern California. What’s a wealthy retired dentist in La Jolla supposed to do now with his dough?

The low rate environment serves a purpose. It gets people to take riskier bets instead of putting their cash under the mattress. This is what Keynes suggested was the way to get the economy going. Rich people hoarding cash helps no one. And we live in a Keynesian world now, whether we like it or not.

The stock market has also never been more accessible for people. How many of your parents had a stock account in the 1980s? Indeed, stocks seem to play a different role in society than they once did. In 2006, we compared house prices at dinner parties. Today, it’s much more common than it was to talk about single stock performance (again, I admit my sample might be small). Obviously, we saw that a bit with Robinhood last year but I don’t think the trend stops. It gets stronger. It may not be the baby boomers who do the investing but one thing that gets missed a lot is just how much the millennials are inheriting (in addition to all that “self-made” crypto wealth). What are they going to do with the cash? My guess is they will invest in the new Tesla stock whatever that ends up being. Perhaps they just buy Cathie’s ARKK.

And even if the FED raises a couple of times, corporate rates will still be 5–7x lower than they were in 2000. Is the market really that expensive ahead of what could be a period of massive technological innovation?

For me, the world is not like the 1970s. It’s like the 1920s. And wealth doubled in the US during that decade. Couldn’t we have 5–10 years of boom time ahead of us? I think so.

I know it’s tough at the moment but my money (NOT FINANCIAL ADVICE) is that the market might be higher by the end of the year, led by tech compounders with high FCF. But for most people, it’s best to just get into a hobby for the next six months and not look at the screens too much. The volatility will cause you to make costly errors. Let’s face it — there are very few Gordon Gekkos amongst us. And wasn’t he fictional anyway?

What about bitcoin?

Apparently, Ted Cruz bought bitcoin at the end of January. He’s no Nancy Pelosi but he is a politician. What does he know that we don’t?

The recent sell off in bitcoin wasn’t like the other ones. It was highly correlated to the risk off move in equities. This is presumably a result of increasing adoption.

But is it time to look at bitcoin and ether at these levels?

A couple of people are commenting on how bitcoin’s volatility profile is normalizing. Does it mean the asset class is maturing? I think so. Both bitcoin and ether continue to make lower lows and lower highs on its 30 day vol. It’s trading in line with energy in terms of vol.

My guess is that means that bitcoin will not enter another winter but it might mean the upside is also limited. Bitcoin price going to USD$500k over a short period sounds increasingly far-fetched but USD$80k? Maybe. Bitcoin won’t be the life changing trade it once was. My guess is uranium stocks might have more upside (NOT FINANCIAL ADVICE).

Bill.com: Great execution

Last week, I used bill.com as the “experiment” stock to show how companies have been sold down too much. It reported on Thursday and it beat as usual.

The stock was up 36% on Friday.

Growth stocks might still fall victim to selling going into the Fed meeting in March and Bill.com is trading at optically expensive valuations so there might be an opportunity to buy it lower still. Nevertheless, it’s a good example of a company in the SaaS space slowly becoming dominant in its vertical with a very sticky product and executing daily, weekly and therefore quarterly.

It’s easy to forget how sophisticated the tech ecosystem has become in Silicon Valley. The stories that get attention are always about the howlers like WeWorks. Perhaps the biggest help to a growing start up, other than capital, is access to top tier enterprise sales talent. Some VCs tell their investee companies who to hire from Series A. And some of the enterprise sales managers are superstars, akin to, and as well paid as, the balance sheet sales guys (fixed income and derivatives) of investment banks before 2008.

To press on the point about SaaS companies, it might make sense to look at another one, in case it gets mercilessly sold down in another factor based rotation out of “growth at any cost” names.

Hubspot, like any other successful SaaS business, enjoys a winner-takes-most market given the high switching costs their customers face. Hubspot is rapidly converting a first-mover advantage into something that can keep compounding. The number of customers it has is still small versus a TAM of literally tens of millions of SMEs and there are plenty of solutions it can introduce to deepen customer spend. It will also look for acquisitions to boost their growth no doubt. The sell off in some names is creating an opportunity to pick certain companies on the cheap. I’m indifferent at these levels but there’s every chance it might become too cheap in a sell off to ignore (NOT FINANCIAL ADVICE).

Amazon’s ad biz

Google and Facebook have dominated digital advertising for years! But there are clear signs that the whole industry is slowly being disrupted. And that’s before Web 3.0. Apple’s move to allow consumers to opt out of ads was a pivotal event. But perhaps, last week’s big story was how well Amazon’s ad business is doing.

For the first time ever, Amazon broke out its ad service business. It did $9.716bn (+33% YoY). That is huge! And represents another reason why META needs to get a move on with its metaverse project.

I am not fond of Mark Zuckerberg but there’s no doubting his business acumen — he might be able to pull something off big but the stock would presumably be dead money for a while now. (NOT FINANCIAL ADVICE).

As always, thanks for reading. If you like it, please sign up to Mateen’s Newsletter — Discuss The Tape | Mateen Chaudhry | Substack.

Best regards

Mateen

DISCLAIMER: None of this is financial advice. The opinions expressed are purely my own opinions and it is imperative for you to do your own research. They do not represent the views of any company I am associated with.

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