(Hay)Makin’ The Podcast Rounds - Part II

In The Ring - August 19th, 2022

”Well, it’s a religion.  It’s totally unscientific.” -Deceased environmental icon, James Lovelock, on apocalyptic climate predictions, who added: “I’m afraid things get exaggerated out of all proportion, and the greens have behaved deplorably instead of being reasonable.”

———

As promised last week, this edition of the Haymaker is a follow-on recap of some of the subject matter that I felt I didn’t adequately address in my recent series of podcasts.  The first is a topic that is once again top of mind for most investors.

Image: Shutterstock

The stock market.  In the June 20th Making Hay Monday, I brought up the highly controversial idea that a rally was likely to start soon.  It was an against-the-grain view at the time because stocks had been well and truly slammed.  At that point, for the year, the S&P was down 22.3% and the NASDAQ was in deep bear market territory, having swooned by 30.7%.  In fact, in the second quarter alone they’d tanked 16.1% and 22.3%, respectively. Bullish sentiment, per BofA’s Chief Investment Strategist, Michael Hartnett, was at a somewhat depressed reading of zero.  Consequently, stocks were deeply over sold, and sentiment was as bleak as it could be, the ideal set-up for a surprise snap-back.

My rally rationale was also based on the quarterly rebalancing phenomenon involving target date retirement funds.  As a quick recap, when stocks have fallen considerably more than bonds, which definitely happened in the second quarter, these funds automatically sell bonds to buy stocks.  They have become so massive, around $3 trillion, that they exert a profound influence on both markets, especially stocks.

The progenitor of this rebalancing theory is my oft-quoted friend Vincent Deluard, Director of Global Macro Strategy for StoneX Financial.  He has found that since target date funds attained market Big-Foot status about six years ago, every quarter during which stocks have taken a licking they’ve come roaring back.  This has usually kicked in about 10 days or so before quarter-end.

---

To learn more about Evergreen Gavekal, where the Haymaker himself serves as Co-CIO, click below.

---

Based on the aforementioned oversold and deeply pessimistic conditions on June 20th, it seemed to me the rebalancing effect could be fairly pronounced.  Right on cue, the market snapped back 6.5% that week, a very big move in a mere five trading days.  As I noted at the time, that was an annualized return of over 300%, a much stronger rally than usually occurs after weak equity quarters.  The magnitude of this also caused me to suggest the rather obvious fact that the returns would likely taper off going forward, which they did… for a while. 

Actually, there were two selloffs, one in late June and the other in early July, that clipped off about 3% each time before the market recovered once again.  But the next leg of the rally, one I didn’t anticipate, began in mid-July, adding another roughly 10% to the first up move.

As many Haymaker readers are aware, it’s been my advice to take some money off the table into this snap-back.  However, I’ve also put out a few buy recommendations, as well, particularly with income investments.  Fortunately, three of those I touted shortly after the rally began on June 20th have performed pretty well, roughly in-line with the S&P since their recommendation date.  This speaks to the fact that credit spreads have been coming down. 

“Spreads”, as they are known on Wall Street, are the ultra-critical differential between what corporations pay to borrow money and what the U.S. Treasury pays.  When they widen, as they were doing for most of this year, bad things happen; when they narrow, which has been happening since late June, it’s extremely supportive of stock prices and, naturally, corporate bonds.  This is why the US Steel bonds I recommended on July 8th have risen by 10%.

Actually, I would go so far as to argue that these falling credit spreads are the main reason stocks have continued rising.  In the case of high-yield (or junk) bond spreads, they have come down from roughly 6% (600 basis points) above treasuries to about 4.3% (430 basis points) over the 10-year T-note yield.  That’s also a serious move and, again, in a fairly short time. 

Earnings have been given credit for the recovery, as well.  Second quarter profits increased around 9% which sounds superficially bullish.  Yet what gets little press is that if you exclude the energy sector, profits actually fell in Q2.  Because energy only amounts to a bit over 4% of the index, it makes this differential extremely eye-opening and, frankly, not nearly as worthy of celebration. 

To that point, Morgan Stanley’s Chief Strategist Mike Wilson ran this chart back on July 25th, 2022.  As you can see, the trend in earnings revisions isn’t exactly uplifting.

Chart: Michael Wilson, Morgan Stanley Research

Frankly, most of my podcasts were on topics other than the stock market, which was maybe a mistake, since that’s what people seem to care most about… at least when it’s rallying.  Ironically, I started my triple-podcast cycle right around the low for stocks and the rally kept on going through my last interview.  Maybe I better get on one again, asap! 

However, even on my last podcast I wasn’t asked if the bear market was over.  If I was, I would have said probably not.  One fascinating factoid in that regard is from David Rosenberg, to wit: “No fundamental bear market ever ended with an inverted yield curve.”  Presently, the yield curve is generally upside down or inverted. The main exception to that is with T-bills and the 10-year T-note where T-bills still yield less.  But with the Fed on a mission to keep jacking up the fed fund rates, which governs the T-bill rate, it’s not likely to stay this way much longer.  

As we all know, or should, inverted yield curves almost always lead to recessions which in turn tend to lead to nasty bear markets.  The median decline in a recessionary bear market is around 35%.  At this time, the S&P is only down about 10%.

Presently, it’s fair to say that such a mild decline merely reflects the big rise in interest rates we’ve seen this year.  Substantially higher rates nearly always cause stocks to fall, usually a lot.  In other words, there’s been no factoring in of even an earnings recession much less the real deal. 

Speaking of, recession fears have unquestionably backed off of late, other than toward oil where they seem to be embedded.  (If I hear “demand destruction” one more time, I might destruct myself!).  However, influential folks such as David Rosenberg, Danielle DiMartino Booth, Albert Edwards, my last interviewer, Erik Townsend, and Ray Dalio’s Bridgewater all feel a recession is virtually a lock.  Personally, I’m not as convinced.  However, as I’ve written a number of times, I do lean that way. 

What we do know for sure is that the drawdowns — aka, losses — in stock, bonds and mortgage securities were epic, exceeding both the Global Financial Crisis and the Pandemic Panic.  As usual, memories are short, and investors today are back in a sunny mood.

The reality is bear market rallies are notorious for being powerful and alluring, a point I’ve made a few times in the past.  The strong up-move in March (yes, that was, once again, at quarter-end!) even caused Jim Cramer to declare the bear market over — right before it came snarling back to life. It’s my suspicion a similar fate awaits this one, particularly with meme stocks and other profitless names leading the way.  The below graphic from The Wall Street Journal is telling in that regard.    

                                    Chart: Spencer Jakab            
                                                                   

To close out this section, I’ll just say I wholeheartedly agree with BofA’s Chief Investment Strategist, Michael Hartnett: “… and don’t think Wall Street unwinds financial excesses of (the) past 13 years with a 6-month garden variety bear market”.

The Great Green Energy Transition.  This is an area about which I obviously have strong, and mainly skeptical, feelings, as many Haymaker readers are undoubtedly aware.  Thus, it may have come as a shock to those in Tom’s audience who heard me say I favor a carbon tax.  While I do, in further reflecting on this topic it dawned on me that standard carbon taxes are too simplistic.  

First of all, unless there is a global carbon taxation it has no hope of being effective.  It’s essential to include the developing world because that’s where fossil fuel use is, and has been, growing by far the fastest.  It’s also because not all emissions are created equal, a point I’ve perhaps belabored in the past.  However, it is simply a fact that CO2 is essential for life while nitrogen oxides and sulfur dioxides, emitted from burning coal, are harmful to humans.  They are also more powerful greenhouse gasses. 

As a result, I believe an optimal carbon tax should more heavily penalize coal-related emissions.  Frankly, the odds of either a conventional global carbon tax or one that taxes coal-based effluents more severely is virtually nil.  Countries such as China and India, along with many on the African continent, will adamantly resist signing such an agreement.  The negative implications to their economies are too severe.

The prevailing mindset, which is so pervasively expressed, that renewables can quickly replace coal, natural gas and oil to power the world continues to strike me as utterly unrealistic.  For example, the U.S. electrical grid has been adding capacity at less than a 1% annual rate for the past 10 years.  Per J.P. Morgan’s Michael Cembalest, it needs to be expanded 5% to 8% per annum to achieve the desired greenhouse gas reduction target.  Based on the ferocious opposition to grid expansions that I’ve discussed before, and we’ve all read about from multiple sources, this is a near impossibility. 

Yet, America is striving for 100% clean electricity by 2035 and net zero by 2050.  Considering that the federal Energy Information Administration projects global energy use to increase by 50%, you can file this one under The Impossible Dream, even in the U.S.  It also forecasts fossil fuels will produce around three-quarter of those power needs.  Columbia University’s Scott Gottlieb cites a McKinsey & Co. report that it will cost the planet almost $6 trillion per year for the next 30 years to achieve net-zero. That’s about 30% of global tax revenues.  Accordingly, it’s my belief that there’s net-zero chance of achieving net-zero.

Image: Shutterstock

Hitting on a theme near and dear to my heart, Gottlieb also opined: “It is increasingly clear that Russia and China view aggressive Western climate commitments as an opportunity to increase their power and influence.” He further noted: “There is a real danger that voters in these countries (Western democracies) will rebel against climate policies that ramp up energy prices, hinder economic growth and even lead to rationing and blackouts.  According to a July NY Times/Siena College poll, only 1% of US registered voters (and only 3% of Democrats) rank climate change as the country’s most important issue, far below inflation and the economy.”

Underscoring one of Mr. Gottlieb’s points, another recurring theme of mine is that green energy is dangerously reliant on China as a supplier.  Sourcing the requisite materials elsewhere anytime soon is right up there — or, perhaps, down there — with a huge growth spurt for the U.S. grid in terms of likelihood.  Lithium is one example but there are many, many others.    

In our podcast, Erik Townsend was kind enough to give me credit for coining the term “Greenflation”. That may or may not be true (not sure when the previous stock image was created), but I’ve certainly harped on it often enough and I was early in warning about the economic pain this was already causing in Europe as far back as last fall.  There are simply not enough critical green resources available at reasonable cost to pull off a project of this scale. This includes the batteries that are needed to power tens of millions of additional EVs.  Most of the inputs for those batteries are exceedingly scarce.

Then there is the diversion of capital away from traditional energy sources such as oil and natural gas, as well as, of course, my bête noire, coal.  This investment starvation is already causing oil and gas inventories to plunge to alarmingly low levels, a situation that is likely to worsen, particularly in Europe.  But even in the U.S. oil and gas stocks are very depleted, especially adjusting for the release of a million barrels a day from the Strategic Petroleum Reserve (SPR).  Globally, SPRs are at a 20-year low.

On a related note, Tom Bodrovics asked me about the Haymaker I wrote on the plethora of apocalyptic climate predictions that have been made over the last 40 years and, particularly, the past two decades. A multitude of these have failed to be validated by facts on the ground… or in the water.  One reader criticized me for cherry-picking though as I have previously indicated, narrowing down the “bad calls” is tough when there are “so many” of them.  

A classic instance of this I didn’t report earlier involves Australia’s Great Barrier Reef.  For decades, the world has been told that it was dying.  However, there was one intrepid Aussie scientist who dissented, Peter Ridd.  For his grave transgression, he was repeatedly and viciously attacked by most of his scientific peers, and ultimately fired.  Yet, today, the Great Barrier Reef has not only failed to die, it’s rapidly expanding. According to the Global Policy Warming Foundation, it’s bigger than ever.(Two major cyclones did materially shrink its mass about a decade ago.)  As far as I know, there have been no apologies issued to Professor Ridd. Undoubtedly, many scientific “authorities” likely wish they could be “ridd” of his arguments altogether.

Chart: GWPF

Yes, I know it’s heresy to report on things like this but as one of the brightest commentators on energy, my anonymous friend Doomberg, has pithily said: “In the battle between physics and platitudes, physics are undefeated.” So, too, is physical evidence.  Once again, I would challenge the press to go back and investigate the claims made by people like Al Gore, particularly when it comes to the extinction of Arctic summer sea ice.  (Mr. Gore predicted it would be gone by 2013; in reality, summer Arctic sea ice is actually more extensive now than it was in 2012.) 

Frankly, I believe this long, long list of failed doomsday predictions is hurting the just cause of trying to greatly reduce truly harmful effluents.  Sadly, there are plenty of those to go around. But to play into the hands of the Russians, as Europe has done, is virtually guaranteed to create a thunderous public backlash.  It’s my fear that the U.S. is doing the same thing with China, though Europe’s exposed to that in a huge way, too.  In the meantime, Europe is reactivating closed coal plants and furiously burning U.S. wood pellets.  Both are extremely deleterious to the atmosphere — and their citizens’ health — in a classic case of unintended consequences.

Note: Haymaker as Host

I actually have one podcast appearance remaining this month. My close friend and longtime business counterpart, Louis-Vincent Gave, will be joining me for a conversation on a variety of important topics, many of which get little mainstream press. It will be recorded late next week and published in early September. Any readers who would like to see the Haymaker host/interview contacts of theirs in the finance, energy, commodities, or banking industries, please feel free to make an introduction.

---

---

Thanks for checking out this week’s Haymaker. Please help yourself to any of the buttons below… multiple selections encouraged.