It was, most certainly, a pearl-clutching week, in a pearl-clutching month, of a pearl-clutching quarter — in a pearl-clutching year.
We can only now hope it doesn’t morph into a bodice ripper.
A strong argument can be made that entering last week’s proceedings, all ingredients for a full-on Heathcliff/Wuthering Heights crash were in place, which only wanted a minor, bothering plot twist to tear the delicate fabric of the current market into shreds. The Gallant 500 had retreated to ~3750 – almost precisely at the levels where it ended 2020 and prior to the >30%, largely joyless runup of ’21.
Down > 10% over a span of a few short weeks, scenarios for authentic capitulation were ascendant. Several important data points loomed — none of which felt like they would serve to increase risk assumption vigor. PPI dropped Tuesday. The Fed spoke on Wednesday.
The increasingly cryptic Bank of Japan followed suit, in short duration, on Friday.
Though nobody much discusses Japan these days, its CB faces a vexing portfolio management problem:
The BOJ Asset Bulge:
The BOJ asset ledger includes $0.5T of domestic stock, including, improbably, 80% of the ETFs issued in the Land of the Rising Sun.
When these figures are added to its gargantuan holdings of its own government bonds, the tally easily exceeds the GDP of the country. We think of ourselves as being naughty here in the States, but the Fed’s Balance Sheet topped out at $9T, a (by comparison) modest, approximate half of the Gross Domestic Product of this great nation.
Plus, while we’re not selling down, stateside, this very week. we are beginning to shed assets by allowing maturing securities to roll off without replacing them.
The BOJ, meeting expectations that puzzle just about everyone, did nothing. Kuroda ain’t gonna use his powers to tame Nipo-inflation. So be it.
BOJ Chair Kuroda-san also reaffirmed the Japanese version of QE – a process known as rate targeting (currently 25 bp).
When the rate reached the usurious level of 0.265%, the BOJ, reflexively, bought paper – in the process wreaking havoc on the cash/futures spread:
Japan is widely admired for its pearl production, which is among the best in the world, so the good news is that the ladies of that country had high quality materials for their pearl clutching – as manifested in the wake of the blowout of the JGB basis trade.
But as near as I can determine, this did little to salve the wounds of those unfortunate souls who trade this spread.
Such are the fortunes of the monetary wars.
Japan and the U.S. also have the following commonality: the special Repo facilities put in place by both jurisdictions to backstop liquidity in the wake of lockdown are now at double the peak utilization manifested during the crisis. But this is where similarities end. On the policy side, the Fed came through with a whopping 75 bp blast – largest since ’94.
But even that wasn’t the biggest pearl clutching moment issuing forth from the world of Central Banking. The Swiss National Bank (SNB), in a move that surprised everyone, raised its policy rate from -0.75% to -0.25% — the first move of its kind in seven years.
And by the way, those minus signs are no typo; the 50bp jacking merely takes the Swiss rates into more benign negative territory. Not sure exactly what’s going on here; the boys and girls in Zurich are notorious for discouraging full-scale conversions into their precious unit of account, but now, with the alluring prospect of only paying a quarter of a percent per annum for the privilege of parking cash at the SNB (vs. 3/4% a few days ago), the temptation for investors may be too great for them not to succumb to it.
Nothing that the Fed was gonna do was likely to redound to the delight of capital allocators, but, for a few fleeting moments, the markets rallied on the 75 bp news. Risk takers thought better of it by Thursday, though, which featured an all-out rout.
In result, the Gallant 500 and Captain Naz reclaimed their ignominious place at the bottom of the Bloomberg Equity Index league tables:
U.S. Equity Indices – Send ‘Em to the Minors:
The ladies faced further moments of shock and awe on Friday – in the form of a gargantuan $3.4T Quadruple Witch/Quarterly Options Expiration.
Nobody’s dead husband materialized therein, bearing family secrets he had blessedly taken to the grave. But – particularly on this type of tape – accidents can happen on the Q4 Witch, which the clutching of all the pearls rendered from all the oysters in all the oceans of all the world won’t counteract.
But we managed, if somewhat worse for the wear, to survive all that. However, just when we thought we was in the clear, what few pearls there are on the Great Plains were no doubt held tight to rural breasts – when 2,000 Kansas cattle dropped dead in a heat wave.
I tried to do some research on my Commadore 64 about this, only to learn that Microsoft had decommissioned its iconic Internet Explorer program. Oh well…
I own no strings of pearls, and probably wouldn’t clutch them if I did, but I was compelled to wrack my brain looking for silver linings in the dark clouds of the investment horizon to bring a shred of hope to my forlorn clients.
I came up substantially short.
The equity complex is in the midst of wicked multiple contraction, to the tune of approximately 1/3rd, and P/Es are now nominally below their 10-year average. So long as the denominator (earnings) holds firm, we probably can take some comfort. But the vibe out there is that earnings are at risk, and the truth is that I don’t know.
I dunno; maybe Q2 earnings drop majestically, maybe guidance will be docile. If not, though, we could be subject to the double whammy of continued multiple contraction against the backdrop of a declining earnings profile.
Won’t that be fun?
But earnings don’t drop for another month or so – after the Independence Day celebration.
Meantime, everyone I encounter is clutching her pearls at the thought of the economy plunging into recession, while inflation continues to rage like the villain in a Barbara Cartland novel.
I don’t have much insight into either plague. My economics training suggests that inflation, once unleashed, is a tough cat to bag. The best hope I can see involves the widely discussed “Whipsaw Effect” which posits that due to all those maddening backlogs, retailers have ordered too much inventory for delivery for the back half of this year and will be forced to slash prices. Like some rogue destroying the upper part of the garment of a fair waif he has encountered and must now have as his own.
This may be deflationary. But even so, it’s hard for me to see the specific contours of a recession emerging in result. It may be looming, but I think those who confidently prognosticate one are mostly spit balling.
Notably, though, the good folks at the Atlanta Fed, who are paid to make these calls, just lowered their Q2 estimate — down to 0.0%:
We’ve seen them hit and we’ve seen them miss with these tallies, but they were right last quarter, which featured a drop of 1.5%. If they are overstating growth now, we will officially be in recession by the end of July.
And we cannot expect much help from our elected officials. There may be some perverse good news in VP Harris being placed in charge of the recently shelved Disinformation Governance Board, where she is likely to do little harm to the cause of free and open debate.
Other Administration initiatives offer less promise. A recent trial balloon featured a windfall profits tax on the Energy Sector, with proceeds to be allocated in the form of gas debit cards issued to the unwashed masses. What better way to deal with rampant inflation for a vital commodity than to disincentivize production while artificially boosting demand?
But they scrapped that initiative because – get this – they couldn’t source the chips to create the specialized cards themselves. Which should tell you all you need to know about the economic issues that we currently confront.
In any event, global and domestic growth are, at best, slowing – at a time when upward pricing pressure is everywhere one meets the eye, and showing no signs of fading from view.
One other thing I can state with some certainty: the market is ill-prepared for any unexpected, incremental negative news. Like a REAL resurgence of the public health crisis. Or the Chinese deciding that now is a good time to cop Taiwan — once and for all.
So, the downside risks remain acute, and everyone is impelled to play defense. Protect the core of your portfolios. De-risk everywhere else.
Presumably, you will also want to locate and secure your pearls, and, if any of you ladies can take even the smallest comfort from grabbing at them and holding them tightly to your person, you’ll get no complaint from me.
And one last bit of risk management advice: make sure that they are linked by a solid string, so that when the handsome cad comes for your bodice, they don’t spill out onto the floor.
TIMSHEL