Conditions Are What You Make of It
Panic at the market
It’s been four years since I have worked in finance. Don’t miss it one bit. However, there were a few experiences that taught me a lot about markets. This is one of them.
One day, the equivalent of a portfolio manager calls all of the interns and junior associates to his corner of the office. We all huddled together, a rare display of solidarity and collective curiousness.
PM: “Can anyone tell me how you would build a signal to determine a country’s willingness to lend?”
As an aside, the group gathered there was arguably the nation’s top young minds in political science, policy, and math. Then there was me. Someone who was anything but that.
PM: “C’mon anyone?“ His tone of voice went from inquisitive to annoyed.
Almost immediately after, one of the junior associates who was skilled in alternative data collection and analysis went through a very plausible way to determine banking sentiment in an automated fashion.
The PM then picked up the office phone, punched in the number to a local Chase branch and was connected to a representative.
PM: “Hey, I am a prospective home buyer. I am inquiring about getting a home loan from Chase.“
Before the teller had any chance to connect him to a Loan Officer on staff. He hung up.
I was meaning to write considerably about inflation and the market for a while. However, my obligation to my employer, my family, and my partner came first. It seems like we are entering into a bit of a panic. As such, I want to caution anyone who might listen to people who have been lucky (macro wise) in the last business cycle with their overtly negative sentiment. They’re falling into a trap and might be bringing you with it.
A Systemic Rebalancing
If there is any graph that you should have seared into your head, it should be this one. For those who don’t know, the WTI Oil Futures contract represents a synthetic price of crude oil produced within the United States. At one point in the market, you could secure a contract and you would be PAID to store oil. This illustrates how unprecedented markets became when faced with the reality of lack of demand from the ensuing lockdowns.
The two years since then have seen a complete reversal with the understandable shift in the geopolitical situation. Soy and wheat got swept at the floor via aggressive stockpiling from the P.R.C. and a war waging in Europe is turning the screws of hurt on cost of living, everywhere.
If you view the market as a way for parties to express their opinions on the cost of things. You should view the prices as the market telling the public that the infrastructure to support commodities is inadequate and requires investment.
Last year, I wrote about “market froth”. This post was talking about the venture environment and somewhat decrying the 30x EPS equity environment and VCs all too happy to fuel that fire. (As well as stuff I am personally excited about)
This snippet feels salient now.
The United States and various corporates learned the hard way by giving up local access to industrial supply; it has effectively demobilized itself economically from a pure ‘atoms’ perspective. As a result, many multinationals now find that cutting-edge manufacturing and supply line optionality is needed to counter against fragile geopolitical realities.
Previously, it was seen as economically inefficient to build within shores. However, as countries and economies mature, realizing the edge of economic growth lies within making science fiction into fact. This means smaller, more capable factories that help companies prototype, design, and develop in-house. While more giant factories enabled by more advanced machinery can respond to increasing demand by retooling more nimbly as demand shifts.
The point I am trying to make is, where oil and other industrials dipped, technology companies skyrocketed. The market as a result underweighted the investment opportunity in the real world. Just because people had to stay home didn’t mean that nothing ever had to be built or made. The ensuring malaise of the underinvestment of (domestic) industrial capacity meant that we would be supply constrained from November 2020 onward.
Tech underwent its mania phase as the only bright spot in a U.S. economy that failed to have innovations, nor a willing labor market, nor a fiscal policy that allowed industrials to prosper between 2008 and 2018. (People forget that the yield curve inverted in 2019 because of what I consider to be an incomplete recovery with warning signs of demand weakness.) Despite the pain, it is now economically feasible to invest in housing capacity, and industrial capacity. It will take time, but this is the medicine the U.S. needs to get off of a painful addiction of cheap capital sourced to the wrong parts of the economy. Not to mention some of our economic policy…
Call Your Foreman
The biggest mistake that most people make when they read economic data is that
They don’t take into the consideration of the lagging nature of the data
They don’t take into the consideration of what the measure instruments
Case in point: CPI. Most of the topline expansion of inflation is housing (duh) and gas. When looking at the other components of CPI, core inputs such as gas are to blame for the rise in cost in food.
When you dig deeper into the components, fright and shipping volumes are normalizing. Industrials are increasing spend on capacity. Canals and expansion projects at ports are greenlit.
Thats not to say that this time will not be a painful one (esp. for those in tech) but spend and investment isn’t slowing down in the areas that need it. You just need to follow the flows and be on the ground. Opportunity and growth are still there, it just doesn’t look like anything you are used to. (Because quite frankly, it hasn’t existed in this country for 40 years.) Even if the Fed hiked rates up 5 percent in one go- it’s likely construction projects would still be on-going.
Look: I wouldn’t wish a recession on anybody and those who are calling for one thinking that they will be on a winning side of a trade is delusional. The layoffs in tech are saddening and asset bubbles deflating means many people will be out of the job. When both my parents lost their jobs via the mass layoffs in ‘08, it meant severe pain for my family and others. This may be no different for some people and families today if conditions worsened.
Where the rhyme ends, the cause of the inflation and sentiment. That makes all the difference, so don’t phone in how you see the economy. Keep your eyes peeled. I am grateful that I have a chance to witness another cycle unfold with you. Best of luck.