Naughty & Nice

The past year has seen its share of headfakes and reversals. It was an easy year to be wrong. With a hostile Federal Reserve and an expensive market, 2022 wasn't a great year for patient buy-and-hold investors. Trading the markets was treacherous but 'holding on' or hiding in fixed income was equally unrewarding. Yes, it was a tough year. But did my blog help this year?

This annual naughty and nice list is an attempt to hold myself accountable for the weekly missives emanating from my weekly Tuesat11 blog. This year has been an exercise in frustration for investors as a downward-sloping, choppy market with multiple blow-ups dragged on. But that exact scenario was my forecast. As we ended 2021 with a sugar high of bubbly Growth stocks, I wasn't a fan of equities. Inflation was seemingly more of an intractable problem and I was uncomfortable with the rate structure. I called for a generally weak market, as the Fed realized its mistake of staying easy too long. I was guided by the thought that stocks are a monetary phenomenon and that monetary conditions were inevitably going to get worse.

I also postulated correctly that the markets would do worse than the economy. That premise only accelerated when inflation soared on the back of a hot war in Eastern Europe. Who expected Putin to go all-in? But black swans are like that - unpredictable.

So as the Risk Model wildly fluctuated from 'on' to 'off', I calmly stayed mostly on the sidelines for the first half. By the beginning of July, in a piece titled "Fed Up", I called for a summer rally based on the excess pessimism that prevailed. By the end of August, I called for a renewed bout of seasonal weakness in my "Schrodinger's Market" piece. That may be one of my favourite titles of the year. I love the imagery of the market that is like a cat in a box - either dead or alive. (I voted for dead.)

In late September, in "Everything Must Go", I argued that the Fed had obviously botched the monetary management so badly that they should be admonished and vilified. But that trenchant bit of trolling was too easy. Remember, Powell & Co. are only bureaucrats, beholden to their bureaucracy. It's the misalignment of their domestic mandate and their global role has them boxed into a corner. Since Greenspan , proactive decision-making isn't part of the Fed's DNA, so don't expect them to get better at micromanaging the economy any time soon. End of sermon.

After the lows of October were plumbed, I called for investors to "Bottom Fish" the many stocks that represented good value. A good call. But the sugar plums of a Fed pivot once again danced in the dreams of cashed-up sidelined investors in November. Markets again rallied beyond their fundamentals, as they had in August. I am now calling for a resumption of the bear trend after the Fed reiterated their hawkish policies during their recent post-decision presser. A near-term Fed pivot seems like a pipedream now. The soft landing I spoke about is still a long shot given their dogmatic backward-looking mindset. Last week's hope rally was truly naughty.

All-in-all, not a bad year for the old guy. I kept from predicting too much optimism while still arguing for a bit of patience and suggesting a couple of good trades. It still applies in the current environment, given the balance of risks in a difficult transition to higher market-driven interest rates. As the world's monetary systems undergo a wrenching renovation and renewal due to the demolition of QE, volatility will continue to ebb and flow with regularity. Inverted yield curve environments are never a good time to be complacent.

So what will the next year bring? It looks, painfully, the same as this year. It has been a struggle to maintain any sense of optimism, as the hurry-up offense from the Fed clumsily bludgeons risk-takers. Investors are being turned off by the merry-go-round of emotions and are once again retreating to the sidelines to lick their wounds. But with recent evidence of continued flows into risk products, strong credit markets, and stable banking conditions, it would be wrong to completely throw in the towel now. Bull markets are always born during capitulations, so resist the urge to bail out should we make new lows.

Valuation is the biggest troubling issue remaining, especially now as the lagged effects of tight money grind down corporate profitability. The earnings estimates for the S&P 500 still seem too high and a dangerous negative operating leverage environment looms - read Mike Wilson of Morgan Stanley for more on that.

Is there an ah-ha moment in the equity market analogous to the 1987 dust-up that stemmed from a U.S. bond market in disarray? Let's hope this morning's Japanese JGB markdown isn't the catalyst this time. One 23% down day' in a lifetime is all this aged scribe can take. But it can happen again should bonds go 'no bid'.

Markets are built on confidence. Confidence is generated by the collective mindsets of market participants. Like Tesla, Crypto and Twitter have just shown us, the 'value' of any asset is somewhat arbitrary and empheral. Risk markets are held together by joint agreements on the narrative that is the accepted wisdom of the time - but that is subject to change. To argue otherwise is the height of hubris and can often lead to overconfidence and ruin. Unfortunately, confidence has been a scarce commodity lately.

Defensive, short-duration assets will continue to attract cash over the next few years as we unwind the Growth/Meme/Theme driven excess built up during the QE era beta chase. Normalistion of interest rates and a restoration of market confidence will take time. Don't be in a hurry to get to the future, it will arrive when it wants to. Sorry to be such a downer on the eve of Christmas, but the naughty stuff in this market still outweighs the nice.

I hope all of you enjoy good health in the year ahead. This past year saw the passing of three friends of mine who I had the good fortune to know. But there were also many renewed friendships, as the Covid social chill thawed just a bit. Life moves on, as it must do, and all we can do is try to appreciate what we have while we have it.

Cheers, Happy Hanukka, Merry Christmas and Happy New Year to all.

Bob