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MV Weekly Market Flash: Jobs Numbers, Interest Rates and Tech Stocks
MV Weekly Market Flash: When Giants Rule the Earth
MV Weekly Market Flash: India’s Warning to the World
MV Weekly Market Flash: The Bitcoin Follies Go Public
MV Weekly Market Flash: Calm Before the Storm, Or Just plain Calm?
MV Weekly Market Flash: Grand Theories and Mundane Realities
MV Weekly Market Flash: What We Learned in Q1, and What May Await Us in Q2
MV Weekly Market Flash: The Fed and the Bond Market Go At It Again
MV Weekly Market Flash: De-Mystifying Factor Strategies
MV Weekly Market Flash: The Perils of Chasing Innovation

MV Weekly Market Flash: Jobs Numbers, Interest Rates and Tech Stocks

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The main theme of the past several weeks has been the surging economy. A big GDP number last week (six percent growth in the first quarter of 2021), rebounding consumer confidence and the first signs of an uptick in inflation have all supported the narrative that the recovery is here and about to kick into high gear. This sunny take on things had some economists in a positively giddy frame of mind this week ahead of the monthly jobs report published by the Bureau of Labor Statistics this morning. The official consensus of analysts whose job is to forecast macroeconomic...

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MV Weekly Market Flash: When Giants Rule the Earth

Read More From MV

When you’re small, a little change can go a long way. Say that your new start-up company earned $1.00 per share in its first year of operations. In the second year you managed to earn a second dollar, so that your year-2 EPS is $2.00. That’s a pretty impressive growth rate: $1.00 to $2.00 implies a 100 percent improvement. But let’s say that my company which earned $100 last year adds that same $1.00 to its earnings this year. So the point of comparison is $101 to $100, which is a measly growth rate of one percent. The point of...

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MV Weekly Market Flash: India’s Warning to the World

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One year ago – April 23, 2020 – the world was coming to terms in fits and starts with the reality that the pandemic wrought by the Sars2-Cov19 virus was going to be more than a couple weeks of absence from the office and social distancing from friends and family. But while medical experts and laypeople alike struggled to comprehend what this virus was all about, as they studied genetic sequences and hoarded sanitizer and paper products, the stock market had already figured it all out. On April 23, 2020 the S&P 500 closed at 2794, up about 25 percent...

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MV Weekly Market Flash: The Bitcoin Follies Go Public

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A financial firm by the name of Coinbase went public this week, and instantly garnered a market capitalization of $76 billion. How big is $76 billion? Well, it’s bigger than the parent company of the New York Stock Exchange (worth $73 billion at today’s prices). It’s bigger than CME Group, the Chicago Mercantile Exchange that is home to much of the world’s futures, options and other financial derivatives activity (about $64 billion). And it completely dwarfs NASDAQ, Inc. ($26 billion), where the world’s technology superstars and their up-and-coming rivals come out to play. So what does Coinbase do, to make...

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MV Weekly Market Flash: Calm Before the Storm, Or Just plain Calm?

Read More From MV

Here’s a fun little fact. According to the most recent Flow Show report issued by BofA Merrill Lynch, a whopping total of $576 billion flowed into global equity funds in the past five months, since November 2020. To put that number in perspective, it is larger than the $425 billion invested in equity funds for the entire twelve years prior to that. That’s right – more money in five months than in the previous 12 years combined. With all that money coursing through the arterial channels of the world’s capital markets, it is perhaps not so surprising that we have...

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MV Weekly Market Flash: Grand Theories and Mundane Realities

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The sweep of history always looks neater when observed from a distance. We speak with confidence about the natural and human forces that drove the transition from medieval to modern Europe, or the fall of Rome, or the rise of Meiji-era Japan. Easy divisions of the flow of time help us mark our story on this planet. Our distance from them allows us to overlay the actual events of those times with grand theories as to how they came about. Big Government… Even recent history seems to afford us the simple narrative. At the end of the Second World War...

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MV Weekly Market Flash: What We Learned in Q1, and What May Await Us in Q2

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So here we are with a quarter of the year gone by already. One thing we think is safe to say: the world we are observing today is not radically different what we might have imagined at the beginning of the year. When we go back and look at the main themes of our annual outlook from January, there is much that still rings true. Interest rates are higher amid renewed inflationary expectations, the stock market rotation from growth to value has shown itself to be durable, and the path to a post-pandemic world is more or less following the...

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MV Weekly Market Flash: The Fed and the Bond Market Go At It Again

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The old guessing game is back: who’s right? A couple things happened this week to bring this question front and center. On Wednesday, the Federal Open Market Committee (FOMC), the Fed’s monetary policy deliberators, released its economic projections for the near future while resolving to leave short-term interest rates at the current level of zero (technically, a band of zero to 0.25 percent for the Fed funds rate that banks use for overnight lending). The FOMC’s overwhelming consensus is that rates will stay at this level at least through the end of 2023. Also this week, intermediate and long-term interest...

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MV Weekly Market Flash: De-Mystifying Factor Strategies

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A great deal has changed in the world of finance since both of us got into the industry way back in the 1980s. One thing has not changed. Practitioners of the financial arts seem to love nothing more than taking a simple idea and making it sound as densely complicated as possible. No wonder so many people are intimidated by finance. They shouldn’t be! Finance is a bit like knitting: it looks more complicated than it really is. The most elaborate Scandinavian-pattern sweater boils down to just two things: the knit stitch and the purl stitch. Likewise, the most incomprehensible-sounding...

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MV Weekly Market Flash: The Perils of Chasing Innovation

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To somewhat paraphrase William Shakespeare, we come not to bury innovation, but to praise it – though perhaps in a somewhat roundabout way. To be perfectly clear, we are fans of innovation. We applaud the creative process that leads to the possibility for breakthrough inventions that can change our lives for the better. After all, the modern world was built on a couple earth-shattering innovations of the late nineteenth century: electricity and the internal combustion engine. We are potentially on the cusp of some new inventions that, while maybe not quite as far-reaching as the transition from the wood-burning hearthside...

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MV Weekly Market Flash: Jobs Numbers, Interest Rates and Tech Stocks

The main theme of the past several weeks has been the surging economy. A big GDP number last week (six percent growth in the first quarter of 2021), rebounding consumer confidence and the first signs of an uptick in inflation have all supported the narrative that the recovery is here and about to kick into high gear. This sunny take on things had some economists in a positively giddy frame of mind this week ahead of the monthly jobs report published by the Bureau of Labor Statistics this morning. The official consensus of analysts whose job is to forecast macroeconomic trends was for 975,000 gains in nonfarm payrolls. Some, though, were predicting as many as two million new jobs. Offices are reopening, businesses are getting…well, back to business, and they need workers!

Wait, what?

Or so we all thought. The BLS report came out as always at the precise time of 8:30 am today and it was, to use the technical term, a damp squib of the highest order. The actual number of payroll gains according to the report was 266,000, not anything bumping up on a million or more. The unemployment rate, which was supposed to decline by a couple ticks to 5.8 percent, instead notched up slightly to 6.1 percent (it was 6.0 percent the previous month). To add insult to injury, the payroll gains reported last month for March were revised down from 916,000 to 770,000. So much for a blowout labor market.

It is always important to remember that these economic reports always have some variability in them. The BLS report is essentially a survey of a statistical sample of households and businesses conducted over a period of several days sometime in the middle of each month. Over a period of time the reports can illustrate a broad-based trend, but any individual report can always be an outlier. The April report that came out today most likely is that kind of outlier. All indications, today’s numbers notwithstanding, are that the labor market is fairly robust. If there is any problem, it would seem to be that in many sectors employers are finding it hard to fill positions. It may take several months for supply and demand to work themselves out. In the meantime we probably shouldn’t get overly exercised about any single data point.

The Market Weighs In

Stock and bond markets have their own way of digesting this news. Let’s start with the bond market. The big thing going on here, as we know from watching interest rates over the past several months, is inflation. Not the inflation we have today, which is still pretty contained, but the inflation bond investors think we are going to have. The inflation an overheated economy generates will force the Fed to step in sooner than it wants to tighten monetary policy – i.e. reducing its asset purchases and eventually increasing the short term interest rates over which it exerts influence. The hotter the economy runs, according to this logic, the greater the risk of Fed action and thus higher interest rates.

So when the jobs numbers came out today so far below expectations, bond investors jumped for joy. Okay, not literally, though maybe a few hypercaffeinated types really did cut a rug on the trading floor. But the hot take was “bad for jobs, good for rates” and the benchmark 10-year Treasury yield declined by a few points (when bond prices go up, bond yields decline).

This movement in the bond market, in turn, makes its presence felt in equity markets. When you see stock prices go up or down on any given day, the majority of the volume driving those moves comes from short term programmatic trading wired to automatically respond to trigger events. A macro event causing interest rates to go down, all else being equal, is likely to trigger a rise in those parts of the stock market deemed most sensitive to rates. This tends to consist of tech and other types of growth stocks. Sure enough, the tech-heavy Nasdaq Composite is up over one percent this morning on the back of those jobs numbers.

Why is this? It has to do with how these companies are valued. Growth stocks often derive their value from assumptions about the growth investors predict will happen years from now. The cash flows produced by that growth then need to be expressed in present value terms. You do that by applying an interest rate – the “discount rate” – to express a stream of future cash flows in present value terms. The lower the discount rate, the higher that present value number. Hence, interest rate changes have an outsize effect on companies with lots of growth assumptions built into their future performance.

All of this is short-term, of course. We will no doubt get some other number sometime in the coming days that carries a different message, and the algorithms powering the trading programs in the stock and bond markets will go the other way. And so it goes ad infinitum.

MV Weekly Market Flash: When Giants Rule the Earth

When you’re small, a little change can go a long way. Say that your new start-up company earned $1.00 per share in its first year of operations. In the second year you managed to earn a second dollar, so that your year-2 EPS is $2.00. That’s a pretty impressive growth rate: $1.00 to $2.00 implies a 100 percent improvement. But let’s say that my company which earned $100 last year adds that same $1.00 to its earnings this year. So the point of comparison is $101 to $100, which is a measly growth rate of one percent.

The point of this little thought exercise is that the bigger a company gets, the harder it is for that company to put down stonkingly high growth rates. Which brings us to one of the world’s biggest companies: Apple. Earlier this week the tech and communications behemoth announced quarterly revenues of $86.6 billion – a giant number in anybody’s books. Even more impressive, though, was the comparison with the comparable revenue figure from one year earlier, when the company generated sales of $58.3 billion. That translates into a growth rate of 53.6 percent – a head-spinning result for a company of this size.

Tech is the Economy and the Economy is Tech

Apple is not alone. The biggest tech platforms have been on a tear in the last few years, accelerating into warp-speed growth in both earnings and share prices since the beginning of the pandemic a year ago. The chart below shows the earnings (both trailing and forward) along with the share prices for four Big Tech leaders: Apple, Alphabet (Google), Microsoft and Facebook.

How is it that these tech platforms are able to consistently put down growth rates of several magnitudes higher than the overall growth rate of the world economy? Each of the companies shown here (along with others such as Amazon and Netflix, which have grown at similar cadences) has its own business model, but in general they have capitalized on a handful of trends that increasingly define the modern economy. First of all, entertainment. The good citizens of the world spend an inordinate amount of time interacting with screens of varying shapes and sizes, which deliver to them all manner of diversions from streaming audio and video to gaming, social media chat, learning foreign languages or what have you.

Second of all, the cloud. Just about any business anywhere in the world needs a so-called “digital access strategy” if it is going to compete in the big leagues, and that strategy inevitably involves using the cloud for an increasing proportion of business operations and customer interactions. Microsoft, Amazon and Alphabet dominate this space.

Finally there is advertising and the rapid rise of omnichannel marketing wherein engaging with the customer through highly targeted, analytically informed online advertising is critical. Alphabet and Facebook are preeminent in this domain.

From these building blocks of the online economy much else flows across all major industry sectors. In view of this, it is perhaps unsurprising to see how the tech sector dominates the stock market, accounting for about a quarter of the total market cap of the S&P 500. The question on the minds of many is: how sustainable is this? And what, if anything, could bring Big Tech down to a smaller size?

Cometh the Regulator

If the tech firms are left more or less to their own devices (pun not intended…or?) then it would be reasonable to assume they will continue to grow on the basis of organic demand for their services and a massive war chest to spend on buying out up-and-coming competitors. But that might not be a smart way to bet. Regulators are never far from sight when the discussion turns to antitrust and unfair business practices. Here the European Union could be the Beowulf that eventually slays the Grendel of Big Tech.

In this same week in which Apple announced its blockbuster quarterly results, the EU’s competition commission, led by Margrethe Vestager (by all accounts every bit as fearless as that old epic hero Beowulf) brought formal antitrust charges against Apple in connection with the company’s practices in charging commissions and restricting fair (in the EU’s opinion) access to customers through its App Store. The antitrust charges stem from a complaint filed by Spotify, the popular streaming company domiciled in Sweden, about facing roadblocks via App Store business practices that favor Apple’s own streaming service, iTunes.

The EU charges may ultimately amount to nothing – this is far from the first time that Vestager’s competition commission has gone after a US tech giant. But there is every sign that they are up for the fight, and a reasonable likelihood that at some point something will stick. Nor is it just the EU that has the potential to draw blood. The US Justice Department has its own inquiry going on related to Facebook’s advertising practices (indeed, Apple itself has taken aim at Facebook’s ability to use its data-heavy targeted advertising at customers using Apple devices). And then there is China, which aims to have its own version of the Internet encroach on the territory currently dominated by US Big Tech.

All of which is to say that the tech giants will in very high likelihood continued to be an inescapable force in the global economy. But their fortunes are far from certain, and one would be amiss to pay no heed to the potential risks lying in wait.

MV Weekly Market Flash: India’s Warning to the World

One year ago – April 23, 2020 – the world was coming to terms in fits and starts with the reality that the pandemic wrought by the Sars2-Cov19 virus was going to be more than a couple weeks of absence from the office and social distancing from friends and family. But while medical experts and laypeople alike struggled to comprehend what this virus was all about, as they studied genetic sequences and hoarded sanitizer and paper products, the stock market had already figured it all out. On April 23, 2020 the S&P 500 closed at 2794, up about 25 percent from the low point of exactly one month earlier on March 23.

Fully Baked Good News

The market’s carefree optimism was out of step with the general mood of the rest of the world, but there was at least a coherent argument for the bulls to make. Even at that early stage of the pandemic there was already evidence that a vaccine might be closer at hand than had been the case in earlier pandemics. The bull market case in its essence was that of all the possible outcomes that could emerge from this health crisis, the best possible one would prevail. The key to that best possible case was the vaccine. Get the masses of the world inoculated against the disease and the world goes back to normal.

In the immediate days following the US presidential election in November, first Pfizer and then Moderna announced the successful Phase 3 trials of their respective Covid-19 vaccines. The bulls had been justified. The S&P 500, which had stalled out through most of the fall to date, resumed its upward ways. The period from November 2, 2020 to April 22, 2021 saw another 25 percent gain.

Not So Fast

In a sense, though, the market has been trading on forward assumptions for the entire duration of the pandemic up to and including the present day. With that in mind we introduce some sobering data from India, where the pandemic is in the early stages of a new and very dangerous wave.

The above chart shows the seven-day rolling average of new cases and deaths. In just the last two days, Thursday and Friday of this week, the number of new cases was 315,000 and 330,000 respectively – the highest number of single-day new cases registered anywhere in the world up to now (the previous record was set here in the US back in January, at around 310,000 cases).

What is happening in India is playing out elsewhere in the developing world, including Latin America, Asia-Pacific and Eastern Europe. The health care systems in these countries are at risk of being completely overwhelmed. In India, supplies of oxygen are running out at hospitals across the country, with caregivers worried that this will lead to an even greater spike in deaths. Vaccine distribution in many of these countries is haphazard and often not available at all. Most alarmingly for the rest of the world, the rapid transmission is leading to a proliferation of variants, including the B.1.617 variant that is central to India’s recent surge and which health experts are studying closely to understand its transmission and possible vaccine evasion properties.

Simple Model, Complex World

The current setbacks to pandemic progress in India and elsewhere underscore the limits and risks in simple stock market narratives. The best-case narrative factoring into today’s price levels makes some simple assumptions; namely, that a vaccine will beat back the pandemic, consumer demand will quickly return (and indeed will outpace historical growth trends for at least awhile) and the entire unfortunate experience of 2020 and early 2021 will be a distant memory in short order. S&P 500 corporate earnings are expected to grow by 30 percent this year, largely premised on a near-seamless return of demand and no major hiccups in the production and distribution chains supplying goods and services.

But the real world is more complex than any model can accommodate. We don’t know all the potential risks that may emerge from the prolongation of the pandemic in emerging markets. We do know that there is quite a bit of investor capital in these markets. In the first quarter of this year investors purchased $191 billion worth of emerging market debt, much of which is denominated in developed-market currencies like the dollar, the euro and the yen. A prolonged period of economic difficulty for these markets could spell big trouble for fixed income investors. The Indian rupee, for example, has fallen about four percent since this recent pandemic wave began.

It’s fair to say that, on balance, progress towards ending the pandemic is positive. But there are caveats to the positive assessment, and emergent risks to any of the assumptions in the bullish narrative. With all the good news that is already baked into the equation, it would not surprise us to see a bit of a pause in growth. Not a major reversal (although that can never be ruled out). But a pause of sorts would not be an unreasonable scenario in the coming weeks.

MV Weekly Market Flash: The Bitcoin Follies Go Public

A financial firm by the name of Coinbase went public this week, and instantly garnered a market capitalization of $76 billion. How big is $76 billion? Well, it’s bigger than the parent company of the New York Stock Exchange (worth $73 billion at today’s prices). It’s bigger than CME Group, the Chicago Mercantile Exchange that is home to much of the world’s futures, options and other financial derivatives activity (about $64 billion). And it completely dwarfs NASDAQ, Inc. ($26 billion), where the world’s technology superstars and their up-and-coming rivals come out to play.

So what does Coinbase do, to make it so impressive in comparison to some of the biggest and most well-established financial securities exchanges around the globe? It acts as an intermediary for people buying and selling cryptocurrencies, none more so than this century’s version of Dutch tulip bulbs or the South Sea Bubble – namely bitcoin. For a hefty fee – around 0.5% per transaction – Coinbase will attempt to shine a healthy transparency on the mostly murky and frequently unsavory world of cryptocurrency. The company has dreams of one day being the platform of choice in a world without borders, where nations and their currencies have largely dissipated and some kind of decentralized magical force allows humans liberated from their governments to barter, truck and trade with each other in perfect privacy, yet with perfect security. That would be the ultimate realization of the libertarian fantasies proclaimed by bitcoin’s original creator Satoshi Nakamoto (who may or may not be a real person, to this day nobody knows).

The Price of Everything, the Value of Nothing

Needless to say, that perfectly decentralized One World bears no resemblance to the world we actually inhabit. National borders indeed have become more defined, not less so, in recent years as countries have had to face the many discontents wrought on their populations by three decades of no-holds-barred globalization. Nevertheless, as you are no doubt aware, the bitcoin craze moved into a new gear last year and has been blasting through milestone after milestone so far this year, as shown below.

That chart says just about everything you need to know about Coinbase and its sky-high valuation. As bitcoin goes, so goes this one-trick pony of a financial intermediary. Which brings us back to that never-ending topic of discussion: what exactly is in store for the legions of the crypto faithful?

Digital, Yes. Decentralized, Probably Not

We have written at length in other commentaries, as well as our annual outlook earlier this year, about the ways in which bitcoin and its ilk fail to serve an effective role as currencies. They are terrible as a unit of measure due to the wild day-to-day volatility. That volatility also makes them sub-optimal as a means of exchange. Businesses would have to contend with uncontrollable swings in their profit margins, making them less stable as enterprises. Finally, as a store of value these cryptocurrencies are only as valuable as the market’s perception. In this way they really are more like 17th century Dutch tulips (at one time a single bulb could buy you an actual house along one of Amsterdam’s canals) than they are like today’s industrial commodities. They don’t actually serve a purpose. They’re not even something pretty to look at. The tulip bubs had that, if nothing else.

But there is another and perhaps more compelling reason why bitcoin could wind up on the trash heap of speculative financial history sooner rather than later – and that has to do with another variation of digital currency. Several stories in the news this week talked about the rapid advancement China’s central bank is making in the creation of a digital renminbi (the country’s national currency).

China’s renminbi project is essentially an alternative form of digital currency to the decentralized blockchain technology that underlies bitcoin. Central bank digital currencies (CBDCs) such as the renminbi are governed by the rules and processes of the sponsoring central bank. In effect they act as digital cash. Just as with physical cash – banknotes and coins – you can transact without the intermediation of a bank, likewise CBDCs would be a relatively seamless way to transact for goods and services without debit or credit cards, or paper checks, or even a payment service like Venmo or Apple Pay that still is linked to an intermediated account. China has a head start in this arena, but other central banks are likely to follow.

CBDCs thus actually do solve a problem, where decentralized cryptocurrencies do not (and will not, for as long as we have a financial system defined by the rules and regulations of national borders). It is relatively easy to imagine a world in which central bank digital currencies become an increasingly important part of the global payments system. It is much less easy to imagine a financial world ruled by decentralized blockchain. Not impossible, mind you. But very difficult.

MV Weekly Market Flash: Calm Before the Storm, Or Just plain Calm?

Here’s a fun little fact. According to the most recent Flow Show report issued by BofA Merrill Lynch, a whopping total of $576 billion flowed into global equity funds in the past five months, since November 2020. To put that number in perspective, it is larger than the $425 billion invested in equity funds for the entire twelve years prior to that. That’s right – more money in five months than in the previous 12 years combined. With all that money coursing through the arterial channels of the world’s capital markets, it is perhaps not so surprising that we have seen such follies in recent weeks as the GameStop circus, the stratospheric valuation multiples of companies like Tesla, and the blind zealotry in pursuit of whatever exactly it is that cryptocurrencies have to offer in the way of value. Or NFTs – non-fungible tokens – those Internet GIFs given the stamp of “authenticity” by blockchain that makes your Sail Cat clip unique from all the other Sail Cats that billions of people have already viewed and thus worth – tens of thousands, apparently. It’s Beeple’s world, and we’re just existing in it.

$40 Million on 25

All melt-ups have their Cassandras foretelling gloom and doom ahead. This week a trader (or perhaps several traders together) put a $40 million bet on a complex options strategy that will pay off if the CBOE VIX index is above 25 by July. The VIX, no stranger to our weekly commentaries, is popularly known as the market’s “fear gauge”. Below is a chart showing the VIX along with the S&P 500 for the past ten years.

As the chart shows, the VIX tends to spike up during equity market selloffs. Each of those Alpine peaks corresponds to the periodic corrections we had in the stock market over the last ten years up to and including the pandemic. The market pullbacks were relatively brief during this period, and the VIX subsided each time accordingly, though it stayed above the level of 20 – widely regarded as the “fear threshold” – for nearly a full year after the Fed calmed things with its unprecedented flood of credit markets intervention last March.

Whoever put that $40 million down on the VIX going back above 25 by July (it currently is around 17) is betting on a sizable pullback in equities sometime between now and then. He or she or they have company (though perhaps not as audacious in putting their money where their mouth is). From fundamental valuation multiples to technical chart indicators to fuzzy “sentiment” gauges, the market is flashing a number of cautionary signs, and market pundits are taking note.

There (Still) Is No Alternative

Any bet on a short-term correction, though, should consider the larger picture. The global economy is set to grow for the next several quarters, at least, at levels not seen in decades. Companies will start to report sizable earnings rebounds when the Q1 earnings season commences next week (and Q2 should look particularly robust as the comparison period will be Q2 2020, when the peak effects of the pandemic lockdown were felt). A number of economists believe this economic growth cycle could be stronger than the last one (and that one, from 2009-20, was the longest on record).

And yes, there will probably be some inflation to go along with the growth. Wholesale prices were higher in March than economists had expected, with the core Producer Price Index (PPI) registering a year-on-year gain of 3.1 percent. China’s PPI grew 4.4 percent in March. Inflationary expectations have been the driver behind the recent pickup in intermediate and long-term bond yields. But the Fed, for its part, remains very calm about prices and does not plan to change its accommodative monetary stance if consumer prices start trending above its longstanding two percent target.

The basic fact remains that there are not a whole host of alternative choices for all that money that has flowed into equities. TINA – there is no alternative – has been a staple influencing factor in investment decisions since the Fed first started its unconventional quantitative easing programs early in the last decade. Share prices could certainly teeter in the coming weeks, and that $40 million options bet on volatility may well pay off (it could likewise wind up being $40 million down the drain). As with any pullback strategy, timing is everything – and in the end, timing is a fool’s errand.

MV Weekly Market Flash: Grand Theories and Mundane Realities

The sweep of history always looks neater when observed from a distance. We speak with confidence about the natural and human forces that drove the transition from medieval to modern Europe, or the fall of Rome, or the rise of Meiji-era Japan. Easy divisions of the flow of time help us mark our story on this planet. Our distance from them allows us to overlay the actual events of those times with grand theories as to how they came about.

Big Government…

Even recent history seems to afford us the simple narrative. At the end of the Second World War the US stood alone as a global economic superpower. Through a combination of far-sighted benevolence and self-interest, so we tell ourselves, we sponsored the Marshall Plan to rebuild a war-torn world, exercising tolerance to our former enemies as they reconstructed and reformed their devastated lands. A thirty-year period of worldwide economic growth followed under the Bretton Woods agreement, the framework fashioned by the great and good at the eponymous New Hampshire resort in 1944.

Governments were the lead agents in the world of Bretton Woods. Here in the US government’s share of the total economy, already at a high level following the reforms of the Depression-era New Deal, grew throughout the 1950s and 1960s. The Cold War gave rise to the military-industrial complex. The Eisenhower administration spent billions on national infrastructure, including the interstate highway system. Social welfare programs and the Vietnam War drove budgets ever higher in the 1960s. Businesses from manufacturing to communications to finance were highly regulated. At one point the top marginal tax rate was 92 percent.

…To Small Government…

 The postwar Bretton Woods framework finally fell apart in the 1970s, and from its ashes rose the Phoenix of privatization, globalization and deregulation. Big corporations went from being the villainous Scrooges of popular culture to being glorified. In the age of “greed is good” the shareholder was dominant, the government was the problem, and all the riches of the world were there for the taking by whoever could come up with the best cash flow model. Regulation was not needed because the market itself was self-regulating. Human self-interest – greed itself – would correct and reverse any excesses.

The advent of the commercial Internet in the 1990s seemed to put a final definitive stamp on this era, ensuring that not only businesses could roam the globe, but so could people. National borders were becoming quaint relics of a distant past, clunky obstacles to one global village, with low taxes and cheap consumer goods for all. It was, in the popular mindset, the literal end of history. Until it suddenly wasn’t.

…And Back Again?

This simple narrative of the postwar world now has a new chapter in support of an old theory. The theory is the idea of multi-decade economic wave cycles. In one cycle private enterprise and free markets loom large; in the next they are eclipsed by Big Government and spending and regulations, and then back again in a never-ending oscillation. The next big shift is now at hand, according to the theorists. In the last twelve months alone we have spent over $5 trillion in fiscal relief and stimulus to combat the effects of the coronavirus pandemic. Now President Biden and his administration are rolling out the details of a $2 trillion infrastructure program, potentially followed by another $1 trillion in other forms of social spending. Taxes, in particular corporate taxes, are set to rise. The big problems of our era – climate change, public health, income inequality, education – are all in clear focus for government to solve.

The idea that this is hard evidence of the next big turn in the wave cycle theory is almost irresistible. Theorists will draw direct analogies with the previous transition from big-government Bretton Woods to small-government Thatcher/Reaganism. Just as the 1970s was a decade of stumbling through the fog after Nixon took us off the gold exchange standard in 1971, so too were the 2010s a decade of groping through a slow-growth, central bank-funded miasma after the globalization-era Masters of the Universe lost their invincibility during the 2008 financial crisis. Now, say the theorists, the new era is at hand.

Pop Goes the Narrative

Except that reality is always much messier than theory. What we are going to be seeing in the coming weeks and months is not any kind of smooth, inevitable transition to a new world of big government. We will instead be witnessing the mundane reality of negotiations, compromises and fudges – the world of actual policymaking. Yes, the Biden administration is making a big bet on what it thinks is the right way to address the many pressing problems we currently face as a nation. But that infrastructure program has miles to go before it becomes law. The administration will have to deal not only with the near-certainty of no help from Republicans to divisions within its own side. Outcomes here are far from certain.

It has always been thus. It is worth remembering that the Marshall Plan – that sweeping reconstruction plan that made those first twenty-five years of postwar growth possible – barely passed through Congress. A couple more votes from recalcitrant isolationists would have torpedoed the deal, and the world would very likely look a lot different today as a result. It’s worth remembering that Ronald Reagan’s victory in 1980, heralding the era of small government, was due more to the (for Jimmy Carter) unfortunate timing of a recession and the Iranian hostage crisis in 1980 than it was to any sweeping natural force of history.

Theories of history are fun for salon chatter and late-night college dorm bull sessions. But we are still far from having our current era written into the history books as a definitive narrative. For now, it’s all about the gritty sausage-making of policy, one day at a time.

MV Weekly Market Flash: What We Learned in Q1, and What May Await Us in Q2

So here we are with a quarter of the year gone by already. One thing we think is safe to say: the world we are observing today is not radically different what we might have imagined at the beginning of the year. When we go back and look at the main themes of our annual outlook from January, there is much that still rings true. Interest rates are higher amid renewed inflationary expectations, the stock market rotation from growth to value has shown itself to be durable, and the path to a post-pandemic world is more or less following the script of the increasing availability of vaccines. As summer approaches we should be feeling our way back to some semblance of normality in the activities we used to take for granted.

That is certainly a marked contrast from the first quarter of 2020, the final weeks of which looked nothing like the world we observed as we got back to work in the early days of that year. Here’s to the joys of no momentous change – and to getting those vaccines into all the arms still waiting for their turn.

Economic Fragility

That being said, a couple things happened this week to remind us that it is never a good idea to sit back and assume that all is well. Every time we look at one of those headline macroeconomic data releases – GDP, inflation, the jobs report or what have you – we have to remind ourselves of the incredibly complex pieces of machinery that make up the global economy.

These intricate connections are highly susceptible to disruption – say, when a container ship runs aground and spins sideways in the middle of one of the most important pieces of maritime real estate. A container ship called Ever Given did just that this past Wednesday. According to a press release from the ship’s operating company, it met with an unexpected gust of wind while proceeding through the canal’s narrow fairway, turning it in such a way as to hit the sand banks on both sides of the passage.

The blockage, which will last at least until the middle of next week, will have a major impact on shipping costs, which are already high for a variety of other reasons. Freight costs have been putting pressure on corporate margins across a range of industry sectors, and those will likely go higher still. Companies will have to figure out how much margin compression they are willing to live with and how much they could potentially pass on to their end markets in the form of price inflation. Inflation, of course, has been a constant news story throughout the first quarter and is not likely to become less important any time soon.

Geopolitics Don’t Matter, Until They Do

Another handful of stories this week focuses on the growing tensions between China and its major trading partners. Now, geopolitical events normally have a fairly muted impact on investment markets. Most investment strategies are predicated on the assumption that the backdrop political picture stays the same – that the world’s nations will continue to trade with each other and their citizens will continue to purchase goods and services with little regard paid to any political considerations.

The sharpening edge of relations with China matters more than many others, though, because it is the world’s second-largest economy, the largest consumer of most major industrial commodities, a big value-added part of the global supply chains of the world’s leading enterprises and, of course, home to more domestic consumers than anywhere else on the planet. Uncomfortably for its trading partners in North America, Europe and elsewhere in the Asia Pacific region, China is also an authoritarian state with a conspicuously poor track record in human rights. Recent examples of its ill will focus on the rapidly disappearing freedom accorded to the citizens of Hong Kong, and the abusive treatment of the Uighur minority population in the far western province of Xinjiang. This week, a series of tit-for-tat sanctions on high-ranking individuals went back and forth between a coalition of the US, UK, EU and Canada on one side and China on the other. Among other things, the sanctions put in jeopardy a major trade deal between the EU and China that was put in place at the end of last year but has yet to be ratified. China is an incredibly important market for many export-dependent companies in the EU.

Geopolitics Meet Markets

The hostilities are being felt directly in the corporate world as well. Two major retailers – Nike and H&M – are the targets of a potential boycott in China due to positions both companies have taken in opposition to the abuses in Xinjiang. Nike and H&M have sizable operations in China – as does almost every other prominent mass market retailer you could think of.

On the other side of this coin, the US SEC raised this week the possibility that Chinese companies with US stock exchange listings could risk de-listing if they are not more transparent in providing US regulators with access to their domestic financial records (this is something nominally required of any foreign company listing in the US but has not been strictly enforced in the past). This would be a huge deal for global institutional investors with sizable holdings of names like Alibaba and Tencent in their portfolios.

All of this is just from a single week’s worth of news. So as we head into the second quarter it is safe to say that there will be no absence of things keeping us focused on our day-to-day analysis. We believe that our portfolio models are allocated in a way well-suited to the current environment – but there is always the potential for that to change.

MV Weekly Market Flash: The Fed and the Bond Market Go At It Again

The old guessing game is back: who’s right? A couple things happened this week to bring this question front and center. On Wednesday, the Federal Open Market Committee (FOMC), the Fed’s monetary policy deliberators, released its economic projections for the near future while resolving to leave short-term interest rates at the current level of zero (technically, a band of zero to 0.25 percent for the Fed funds rate that banks use for overnight lending). The FOMC’s overwhelming consensus is that rates will stay at this level at least through the end of 2023.

Also this week, intermediate and long-term interest rates kept rising steadily, with the 10-year Treasury yield pushing through 1.7 percent. That’s not a particularly noteworthy level – the 10-year was trading over two percent as recently as summer 2019. But the pace of the increase has been of concern to market observers. Treasuries are supposed to be the ultimate safe haven investment, so when volatility rises to unusual levels, people notice. The sharp rise in bond yields strongly suggests that the market is not buying into what the Fed is saying about the economy, inflation, and its short-term rate policy. Who’s right?

Sugar High with a Touch of Inflation

The big number that got everyone’s attention at the FOMC press conference was the GDP projection for 2021. Just three months ago, at the December meeting, the median growth projection was 4.2 percent; on Wednesday we learned that the Fed now expects GDP to grow at 6.5 percent. That’s more than at any time since 1983. The chart below shows the ten-year trend for year-on-year GDP growth along with inflation, using the Fed’s go-to measure of core personal consumption expenditures (PCE). We indicate where the Fed expects each of these numbers – GDP and inflation – to be in 2021.

So the Fed expects core PCE to be 2.2 percent in 2021, also higher than its December projection of 1.8 percent. But as the chart shows, 2.2 percent is only slightly above the peak levels the index reached on a couple occasions in the low-inflation economic cycle of the 2010s. Why does the Fed think the much higher GDP growth rate won’t entail a more robust bout of inflation?

The answer articulated by Fed Chair Jay Powell during the press conference, and consistent with everything he has been saying for many weeks now, is that the 2021 growth will be more of a sugar high than it will be a sustainable trend. By 2023 the Fed thinks growth will have subsided back to the pre-pandemic trend of somewhere around two percent. The median FOMC projection for GDP growth in 2023 is 2.2 percent (actually down from a 2.4 percent projection in December) and the long-run assumption is just 1.8 percent. Those are not numbers likely to generate a bout of 1970s-style inflation. That, in turn, is why the Fed is so confident it can keep short-term rates so low, for so long.

The Bond Market is Vigilant, and Sometimes Wrong

So-called bond market “vigilantes” have a long history of doubting the wisdom of Washington, such as it may be, on matters of financial rectitude. The sharp rise in yields that has characterized much of the current year to date is the most recent manifestation of this conviction that a flood of easy money will inevitably lead to soaring consumer prices. However, the bond vigilantes have been known to be wrong. In the chart below we show a couple instances in the past ten years when the market got ahead of its skis.

Back in 2013 there was a growing consensus in the bond market that economic growth, which was kicking into a higher level with a steady improvement in the labor market, was going to engender inflation and require the Fed to tighten the flow of money. All the bond vigilantes needed was a catalyst, and then-Fed chair Ben Bernanke supplied it with one word: taper. As the chart shows, a dramatic rise in rates followed this Delphic one-word musing. But inflation, measured here by the core consumer price index (CPI), didn’t go bananas, as we all now know. And the Fed kept its policies largely in place for the next two years.

The second instance of bond yields overshooting themselves happened in late 2016, starting the day after the presidential election. Because of a single mention of “infrastructure” in the victory speech that evening, a consensus formed overnight that a massive wave of public spending was about to be unleashed. That flood of money pouring into new roads and bridges and whatnot was sure to – all together now – unleash a major surge of inflation. Of course, the infrastructure programs never happened and the inflation never surged. But give the bond vigilantes credit – they are consistent no matter what.

So here we are at Reflation Trade – The Sequel (or Part Deux if that’s more to your taste). This time the bond vigilantes at least have some more data on their side, in the form of the trillions of dollars already deployed to fight the pandemic and bring the economy back to health. And yes – there is a possible infrastructure program in the works and there is even a somewhat reasonable chance that something could actually pass. Plus, of course, the expected surge in demand we expect will come about in a newly-vaccinated world by the second half of this year.

So the vigilantes might get their day in the sun. But we also find very little to quibble with in Jay Powell’s more measured take on longer-term economic expectations. What happens in 2021 is most likely to be a highly unusual confluence of events, following the extremely unusual things that have transpired over the past twelve months. It’s way too early to make a final ruling on who’s right. But of all the old sayings in the financial industry that really have stood the test of time, “don’t fight the Fed” is probably still at the top of the list.

MV Weekly Market Flash: De-Mystifying Factor Strategies

A great deal has changed in the world of finance since both of us got into the industry way back in the 1980s. One thing has not changed. Practitioners of the financial arts seem to love nothing more than taking a simple idea and making it sound as densely complicated as possible. No wonder so many people are intimidated by finance. They shouldn’t be!

Finance is a bit like knitting: it looks more complicated than it really is. The most elaborate Scandinavian-pattern sweater boils down to just two things: the knit stitch and the purl stitch. Likewise, the most incomprehensible-sounding hedge fund strategy is ultimately about nothing more than the timing, magnitude and level of uncertainty around a series of future cash flows. Once you get the basics down, the rest is relatively easy. That’s the little secret the industry desperately wants you not to know.

Smart Beta, Dumb Marketing

So let’s take a look at one of the popular buzzwords in today’s markets: factor investing. What does that mean? It sure sounds impressive. You might hear a sales pitch in which the smooth-talking industry maven casually intertwines “factor investing” with another beloved piece of gobbledygook: “smart beta.” Wow, a Greek letter and everything! You’ll hear how this is the way the pros invest now, you’ll hear the words “quantitative” and “algorithm” repeated over and over again, and the amygdala section of your brain might light up with residual fears of the binomial theorem you hated so much in eighth grade algebra.

We’re going to show you a picture of what a factor strategy looks like in the chart below, so as to de-mystify all the silliness. We’ve chosen two factors with which you are probably familiar: value and growth.

A Factor Is Just a Point of View

Yes, value and growth, those old standbys of asset class diversification, are factors! You might know them as “styles,” because that’s what they were before they became “factors.” It’s just a new word for an old concept. Style investing became popular in the 1990s, following the academic research of folks like Eugene Fama and Kenneth French in the early years of that decade. In fact, Fama and French came up with a model that discovered (based on long-term data they studied from over the three previous decades) a sustainable advantage to investing in small cap versus large cap, and in value versus growth. Hence the Fama-French Three Factor Model – yes, they called them “factors” but the fashionable investment strategies that proceeded from their research in that decade preferred the term “style.”

Until now, when the fusty old academic term became retro-chic. Meet the new boss, same as the old boss. A factor, or a style, or whatever else you want to pull out of Roget’s Thesaurus, is just a point of view. And not necessarily one that lasts. Consider that chart above. The factor that has shown its dominance over this recent five-year period wasn’t Eugene Fama’s value effect at all: quite the opposite.

So What About that Smart Beta Thing?

But wait, you might say, what about that other phrase, the one with the intimidating Greek letter? Yes, the financial industry does love its Greek alphabet, from alpha to omega. “Smart beta” is just another way to say factor, or style, or point of view, or any other phrase easily constructed with the twenty-six letters of our own alphabet. In case it ever comes up, though, here is the etymology.

So first of all, plain old beta is simply a measure of relative risk. Take a broad market index, like the S&P 500 or the Russell 3000, and assign it a beta of 1.0. Then you measure the variance of a single asset – could be a single common stock, or an ETF representing an industry sector, or a mutual fund – against the benchmark. If the asset varies by more than the benchmark it will have a beta greater than 1.0 – in other words, more risky. Less variance means a lower beta. So good old fashioned beta means investing according to whether you want to assume more risk than the market, or less risk.

“Smart” beta really is not smart at all. Just different – again, a different factor, a different point of view. Do you think that stocks which have recently outperformed the market will keep on outperforming? Then you may choose momentum as your factor. Or you may think the wheel is going to turn and the “dogs of the Dow” are due for their day in the sun. Or you may get technical and cull out stocks which exceed a certain financial threshold: say, the stocks in the S&P 500 in the top 10 percent according to return on equity, or cash flow return on invested capital, or the lowest level of net debt to total equity. Or a mix of all of the above.

Factor outperformance comes and goes. Even the most durable – like the small cap and value factors Fama and French detected back in the early 1990s – are vulnerable to the tectonic shifts that happen in markets over long time periods. The more ephemeral ones can pop into and out of favor within much shorter time frames. Many of them rely on adroit market timing, and market timing is a fool’s errand.

None of which is to say that factor investing is a bad idea. Different points of view should, if done properly, add to a portfolio’s diversification, which is s a good thing. But there is nothing mysterious about factor investing either. Knit one, purl one. Cash flows matter, and the rest is just conversation.

MV Weekly Market Flash: The Perils of Chasing Innovation

To somewhat paraphrase William Shakespeare, we come not to bury innovation, but to praise it – though perhaps in a somewhat roundabout way. To be perfectly clear, we are fans of innovation. We applaud the creative process that leads to the possibility for breakthrough inventions that can change our lives for the better. After all, the modern world was built on a couple earth-shattering innovations of the late nineteenth century: electricity and the internal combustion engine. We are potentially on the cusp of some new inventions that, while maybe not quite as far-reaching as the transition from the wood-burning hearthside to central heating, are nonetheless exciting, with possible solutions for social imperatives ranging from climate change to personal health and longevity.

The point of this article is not to pass judgment on the fundamental merits of any innovation, nor on any securities or funds that purport to offer investment exposure to such innovations. Reasonable people can argue the pros and cons of any aspect of the invention or the underlying investment strategy. Our point here is one about investor behavior. It is a reminder of how things can go wrong when one chases innovation in the expectation of outperforming short-term returns.

A Story in Three (So Far) Phases

The chart below shows the three year return history of three stocks that are popular holdings in many innovation-themed investment strategies: Tesla (clean technology), Spotify (streaming entertainment) and Zillow (financial technology).

We have divided this history into what appear to be three fairly distinct phases. Now, when you look at this chart, try to think about it in the way say, an investment consultant might look at it. Investment consultants are in the business of recommending asset selection choices to individual investors and institutions like the investment committees of pension funds and charitable organizations. While many factors can potentially come into play during this selection process, it is well-established that a high premium is placed on recent returns performance relative to some benchmark index.

In the chart above you can see that for about a two year period from March 2018 to March 2020, these three securities were pretty unimpressive in their performance relative to the S&P 500, as a benchmark. They were underwater on a relative basis for much of this time (barring Tesla’s wild swings up and down during the first three months of 2020).  We call this the “meh” phase, because that is the kind of response this performance would elicit from an investment consultant looking for outperformance versus the benchmark. There was plenty of innovation in all three companies during the “meh” period – there just weren’t the kind of returns that would impel the investment consultant to chase the innovations.

Wow, Look At That!

That fairly blah track record changed dramatically almost as soon as the Fed came riding to the rescue of the pandemic-shocked market in late March 2020. Suddenly these stocks and many others of a similar nature went into a hyperspeed ascent. The themes resonating with investors in 2020 included large-scale speculation on riskier names with little in the way of current earnings but with arguable (innovation-driven) potential for future growth. That as yet uncertain growth was made much more attractive in present value terms by plummeting interest rates. The yield on the 10-year Treasury, the world’s most widely-used reference point as the risk-free rate from which cost of capital calculations are constructed, fell to half a percent in the months after the Fed’s rescue efforts.

So again, think of the mindset of our investment consultant as she ponders asset selection decisions at the end of 2020. Kind of hard to ignore the stonking performance of any fund heavily invested in these innovation themes, no? Even harder because the innovation theme was such a prominent subject on social media. “Hey, why aren’t you invested in X?” is usually something an investment professional hears from a client only after X, whatever it is, has recently been soaring like a rocket.

Wait, What Just Happened?

Spare a thought if you will for our diligent investment consultant who couldn’t resist the temptation to go all-in on the innovation theme as the calendar year transitioned to 2021. These names kept going up for awhile (the market doesn’t pay attention to the Julian calendar that guides our lives) but hit a peak in mid-late February and have all fallen at bear market levels (20 percent or more from the high) since then. Not because the basic nature of the innovations is any different, but because the interest rates that were so friendly to speculative names in 2020 are much more onerous today. The 10-year Treasury is more than one percent higher today than it was in the middle of last year. That makes a vast magnitude of difference to the present-day valuation of highly uncertain future cash flows.

So is the lesson here simply not to invest in the promise of innovation? Certainly not! The trick is to do the work that leads you to a potential innovation before it has become the subject of cocktail party conversations and social media one-upmanship. You may be holding that exposure for a long time before it becomes the next great thing. In fact, chances are higher than not that it never will become the next best thing. There were hundreds of automotive companies that went bust, belly-up, kaput before Henry Ford came along with the Model T. The dot-com bust left the ashes of thousands of New Economy darlings behind while a few like Amazon ascended to the stratosphere. The next wave is likely to be no different.

Investing in innovation is not a fundamental, core component of a long-term investment strategy. It is something to do with a small slice of your total net worth – an amount you could live without if its value were to go to zero. Innovation is exciting, and there will always be the temptation to put one’s money to the test to see if that little entrepreneurial dream becomes the next Apple or Google. If you have the stomach and the nerves to buy in before everyone on Reddit is talking about it (and the discipline to not go overboard on the size of your investment) then all the better.

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