Putting our heads together is what Stray Reflections does best. All of us are smarter than any of us. Here’s a summary of the most helpful insights gained from the community in our members-only Slack group last month.
1. Short Hope (#equities)
2. Long Siege (#politics)
3. Short Jokers (#tech)
4. Long FUD (#crypto)
5. Short Protests (#life)
MB (New Jersey): Markets are HARD. The market was hovering just below all-time highs in August 2000 when ISM had been declining all year and sat below 50. From the March peak to August, during the chop, the S&P 500 had three rallies between 8 to 11 percent. The Fed started to ease policy in January 2001 and the official recession began March 2001.
The cause of the recession is debated but most saw the market decline (wealth effect) as the culprit. Earnings grew 9 percent in 2000. Moral to this story is that when liquidity is not flowing when growth is slowing, it’s a risky setup in a market where valuations are elevated.
The Economist cover on December 9, 2000, was titled A Hard Landing? The S&P 500 was down over 13 percent from its all-time high when that issue came out. It didn’t serve as a contrarian indicator.
JM (Toronto): This is an excellent take. I love you for checking my optimism. I don’t agree with the premise that growth or liquidity is as bad as above would suggest. I also think the 2000 analogy for today is erroneous.
Growth is naturally slowing but that’s not a reason to turn bearish. I think US trend real GDP growth is 1.5-2 percent. I’m not worried about negative fiscal impulse and don’t see recession risk at all. If you think growth slowing will lead to earnings declining, then yes, its bearish but that’s not my view. I think people are still underestimating corporate resilience in face of supply shortages and wage inflation.
The macro community over exaggerates the Fed’s role in bull market. Stocks aren’t rallying just because of QE. Fed balance sheet versus the S&P 500 is my most hated chart of the last decade. Liquidity won't “stop” just because Fed is tightening.
As we have written, wages are rising, savings rates are falling, and with banks loan growth set to accelerate, the withdrawal of central bank liquidity is likely to prove less disruptive than what is typically experienced during the late-cycle tightening of monetary policy.
Question comes down to where PE multiples settle. I believe we have fast tracked multiple contraction. S&P 500 PE is down 17 percent, S&P 500 400 midcap PE is down 35 percent and S&P 600 small cap PE is down 50 percent (the steepest contraction ever, more than in 2000 and 2008).
What matters is not the facts today, but the headlines six months from now. Will we be more worried or Iess worried about today's top concerns? Inflation, supply chains, pandemic, wages, earnings, Fed tightening, China policy, global growth.
On each of those points, I believe headlines will be favorable. That’s going to be bullish given current sentiment and positioning.
SG (London): I think the flow picture looks quite poor. Earning beats are consequential and yet stocks are reacting negatively, and the labor market is super good and yet the market is lower year-to-date.
A legendary old school macro guy told me a decade ago: “This bull market will go on until we print sub 4 percent unemployment, earnings beat everywhere, and the market sells off.” I am bearish.
To change my mind, I would want to see: (a) vol moving lower with stocks going higher, and (b) positive reactions to positive announcements.
It’s an extremely tough market especially for people with a bearish disposition. The market isn’t offering cheap downside protection at all (outside maybe in one or two places). The best thing to do is probably to stay on the sidelines and hope to be around to pick up the pieces. Could take a few years to play out.
SW (New York): What do you think the right multiple on the S&P 500 should be here?
MB (New Jersey): I don’t see why multiples should be at January 2020 levels as they are currently. There is a serious risk that we have just witnessed a short boom cycle where we overstimulated aggressively and are now in the bust. I still see no concern from people I talk to on growth.
The Russia-Ukraine conflict is a poor excuse for market drawdown just like any event that is a surprise in a cyclical downturn. We are approaching strong support on the S&P 500 where a tradeable rally can ensue to the theme of “buy at the sound of cannons.”
Best guess we bottom at 15-17x so as an investor I can’t be bullish here yet.
JM (Toronto): In her book When Things Fall Apart, Buddhist nun Pema Chödrön says to “abandon hope.”
It’s not a message of despair, but rather one of clarity. What she’s suggesting is that hope can sometimes take our attention away from what’s really going on.
“We hold on to hope, and hope robs us of the present moment,” Chödrön writes. Even if it’s challenging, she wants us to perceive things and attend to them as they really are.
Am I hoping the bull market continues? So important to be objective right now.
PG (London): Putin’s speech recognizing DNR and LNR was surreal. Recognition itself not an issue, the long historical passage and discussion of threats were insane. He is totally out of touch.
VB (Boston): I agree. His speech was shocking. It was unprecedented in many ways, basically laying out deep and bitter grievances not for the Soviet Union (btw he basically called Lenin a fool) but for nineteenth century Russian Empire. This is an angry country that feels aggrieved. It's dangerous. And at a time when the West is lacking leadership and is fighting its own ghosts.
Prior to this speech I was much more sanguine about what the extent of this may be, but I think I now see a Russia that is intent on creating enough havoc to truly challenge NATO and the EU via threat, coercion or asymmetric warfare. The butterfly effect here could be that lots of other globally important “frozen” conflicts pop to the surface.
With all that said, this is not necessarily bearish. Military budgets will go up, driving tech innovation that is more useful than social media. This could finally be the threat that unifies the US and swings our politics back toward center.
JM (Toronto): The West fails to understand Putin. He made absolutely clear what he thinks in a July 2021 op-ed. Putin regards himself as the heir to the Byzantine throne. Patriarch Kirill of the Russian Orthodox Church said that Putin’s rule was a “miracle from God.”
There are about three hundred million Orthodox Christians around the world. Russia, which accounts for a third of those followers, has long been the largest and most powerful group within the faith’s fourteen jurisdictions. The Grand Duchy of Moscow, the predecessor state of the Tsardom of Russia, claimed the title “The Third Rome” as successor to the Byzantine Empire and the political and religious position of Constantinople and Rome.
This historical reality is deeply embedded in the Russian nationalist psyche. Nations, like people, often get trapped in their own history.
JG (Hong Kong): Doesn’t this increase the odds of a coup on Russia? It feels a little desperate. Who will do business with Russia going forward unless they have to? I don’t get the end game here.
PG (London): For sure it does, a revolution also possible.
SG (London): One (famous) Russian oligarch I had the chance to work for several years described Russia and Putin to me the following way.
You Europeans don’t understand how Russia and Putin works, he isn’t a strongman and Russia is not a unified country. Think of Russia as a medieval fiefdom where Putin is the sitting king. Each fiefdom is controlled by a different faction with a different set of wants and needs.
Information doesn’t flow up to the kind until it’s too late, typically if the local lords or factions want something they do it and then hope to bring enough spoils back to the king not to be decapitated. Anytime Putin goes on the aggressive line, it’s because he doesn’t have a choice and factions have pushed him to do so. Otherwise, he looks weak. Hence, I agree all this increases the probability that some factions inside Russia want regime change.
Especially if you are able to hit their purse hard enough. But that means a lot compared to where we are now. You need to start seizing assets in the UK and Cyprus and basically any jurisdiction where they are parked. and while doing that, you likely push up Putin’s approval ratings.
JM (Toronto): Propaganda and misinformation are rife. Be careful what you read and believe. I suspect this is going to be a long war. Think Vietnam or Iraq. Markets will get desensitized.
Underneath the oil price spike, keep eye on rising US rig counts and output. Iraq and Iran production recovery, and OPEC spare capacity. We’re not headed for an energy shock or WW3. Resist doom porn.
Our salon with Marko Papic (Partner, Clocktower Group) considered the birth of a Machiavellian America, which is countering geopolitical rivals by inciting conflict. The situation in Ukraine–but also with Taiwan–are great examples of this strategy. You can watch here.
KC (New York): This seems like peak foolishness in private TMT to me. Anybody agree or disagree? Joker loses $159 per orders. Orders can’t be more than $20!
ZP (London): It depends. We haven’t invested in any of the instant grocery players but there is something to it. The problem I believe is that most people are looking at the model and likening it to an Uber Eats or Grubhub type model whereas the end-state should be different.
If the instant grocery delivery companies are able to own the customer relationship, then there is an opportunity to displace the traditional grocer and take that place themselves, buying wholesale or even white-labelling goods to substantially increase margins.
A reasonable analogy is Ocado in the UK which delivers groceries and is a listed company that has been around for more than two decades. They were originally just the delivery company for a grocer called Waitrose. Then they switched to become the delivery company for Marks & Spencer and it became very apparent that Ocado held a lot of the leverage because they owned the customer relationship.
Today Ocado is worth 3x (£10.3 billion) the value of Marks and Spencer’s (£3.4 billion) the grocer it delivers for. I would think about Gopuff et al in a similar way. If it can own enough customer relationships directly, can it eventually displace a grocer like Kroger? Of course, whether the risk/reward is there at these valuations is another question.
JM (Toronto): I was in the same camp as KC, helps to know a counter thesis. What ZP seems to be describing is that these startups have the opportunity to power an evolved, local commerce economy by building an effective customer acquisition engine.
While intended for grocery, the technology could easily be applied to retailers, helping them not only with last-mile delivery but more importantly helping them reach out to a larger, local audience to grow their businesses. Meaning their success or failure will depend on growth beyond grocery delivery as the core model. In essence, they must function like a retail operating system. So, grocery delivery was to Ocado what book sales were to Amazon?
ZP (London): Yes, that would be the bull thesis, the instant grocery companies essentially becoming vertical, using delivery to get their foot into the door. Whether they can become more horizontal and sell more general retail goods after that is a much larger step since the way and reason why people shop for groceries is different to other retail goods.
In any case, I do agree with you guys, I would expect most of the companies to end up failing given the unit economics are so poor right now. I can’t fathom how most VCs are throwing money at these companies trying to pick a winner.
JB (Sacramento): As I read about tech, metaverse, fast grocery delivery… I keep hearing Kurt Vonnegut in the back of my mind. He was asked in 1995 to discuss his feelings about living in an increasingly computerized world.
I work at home, and if I wanted to, I could have a computer right by my bed, and I’d never have to leave it. But I use a typewriter, and afterward I mark up the pages with a pencil. Then I call up this woman named Carol out in Woodstock and say, “Are you still doing typing?” Sure she is, and her husband is trying to track bluebirds out there and not having much luck, and so we chitchat back and forth, and I say, “Okay, I'll send you the pages.
Then I go down the steps and my wife calls, “Where are you going?” “Well,” I say, “I’m going to buy an envelope.” And she says, “You’re not a poor man. Why don’t you buy a thousand envelopes? They'll deliver them, and you can put them in the closet.” And I say “Hush.”
So, I go to this newsstand across the street where they sell magazines and lottery tickets and stationery. I have to get in line because there are people buying candy and all that sort of thing, and I talk to them. The woman behind the counter has a jewel between her eyes, and when it’s my turn, I ask her if there have been any big winners lately.
I get my envelope and seal it up and go to the postal convenience center down the block at the corner of Forty-seventh Street and Second Avenue, where I’m secretly in love with the woman behind the counter. I keep absolutely poker-faced; I never let her know how I feel about her.
One time I had my pocket picked in there and got to meet a cop and tell him about it. Anyway, I address the envelope to Carol in Woodstock. I stamp the envelope and mail it in a mailbox in front of the post office, and I go home. And I’ve had a hell of a good time. I tell you, we are here on Earth to fart around, and don’t let anybody tell you any different.
Make sure to watch our digital assets salon with Marcel Kasumovich (Head of Research, One River) if you haven’t already. It was too good to miss.
CT (Puerto Rico): What was most interesting to me from the crypto salon was the thinking behind valuations. I want to add some color around price discovery.
It is clear that crypto prices are the product. Everything has and will be speculatively driven for the foreseeable future. Any attempt to provide fundamental valuations to crypto will fall short until we see strong institutional or mandated buyers.
While traditional portfolio managers mostly manage risk, crypto managers buy and sell actively. This is exacerbated all the way down to the individual retail trader on Coinbase. This is compounded with a lack of systemic buyers. I define systemic buyers as people who need to buy and use the token in order to access the network.
In 2017, the entire reflexive move was driven by ICOs and the enormous, forced buying they created. You needed to buy ETH to access most ICOs. You needed to buy BTC to turn fiat into crypto since almost all trading pairs were against BTC.
In 2020/21 you needed ETH to access NFTs and DeFi and other Layer1 tokens to access the relative ecosystems. Solana is maybe the most egregious example of price getting ahead of this metric. It cost about 0.00001 SOL to make a transaction yet price did a 200x on the public market. This continued to trickle down the risk curve as it does in bull markets—the riskiest, lowest unit bias coins outperforming the way they always do.
When we remove the marginal buyers of a bull market in crypto, we are left with the baseline network usage. This represents the floor transaction volume. Another way to think about this is Total TX volume minus Trading TX volume. No one really knows what this number is because you cannot parse the blockchain data but many have tried.
My previous businesses were in online marketing, and I know the power of a “how to make money” offer. Crypto created the ultimate sales offer. If you follow these steps, you will make money. If you click these buttons, you will make money. This created an army of marginal buyers who needed to buy a token to enter the arena.
As time went on, the ability to make money in crypto has waned. Just go on Crypto Twitter and ask twenty people “how are you making money in crypto right now?” A year ago, there would be a list of ten things. Now it’s few and far between, especially outside of range traders. This is why prices cannot keep a bid. Every move up is simply a squeeze, retracing the entire move in a matter of days.
Thinking about fundamental analysis is really about trying to sell the idea to other people in hopes of buying and holding. Without institutional mandates like the equity market has, you need to convince people to buy and hold for the long term, turning each participant into a Portfolio Manager and not a speculator or trader.
This will change once we see some sort of “institutional network use” which is a way to describe an entity that will use the particular token on a constant, ongoing basis. Think about this like the 401k mandate for crypto. Who is going to commit to using a network in a big way over the long term? This creates a new form of marginal buyer and creates a price floor so to speak.
For this reason, I don’t think it’s worth focusing on the technology or the benefits of the network as much as it’s worth focusing on the sell side strategy for each token for potential usage. Other than BTC and maybe ETH once it becomes a staked bond type asset, everything is trying to find a big user outside of speculators.
Interesting questions about which coins survive revolve around the business development strategy more than the technology development strategy. Who will attract the biggest users versus who will attract the biggest holders or buyers? The best products will not necessarily win. The products that can attract and close the best “clients” will win. Whatever sales pitch connects to the largest systemic users will be around in five years.
Put another way, asset management companies are focused on ESG investments not because they are superior companies but because they can sell those products more easily than value stocks. This, in my opinion, is a more effective way to think about future success and is a model for future crypto valuations.
This poem by Ukranian poet Ilya Kaminsky was shared in the #life channel. It’s an apology for choosing complacency in the face of adversity during a war.
And when they bombed
Other people’s houses,
But not enough,
We opposed them
But not enough.
I was in my bed,
Around my bed America was falling:
Invisible house by invisible house by invisible house.
I took a chair outside and watched the sun.
In the sixth month of a disastrous reign
In the house of money in the street of money
In the city of money in the country of money,
Our great country of money,
We (forgive us)
Lived happily during the war.