Jackson Hole Fears, Bull vs. Bear Cases, Europe in Trouble & More

In this week's MIM edition, we broke down bearish and bullish cases for the second half of 2022, the underlying reasons behind the crypto sell-off, dismal economic data coming out of Europe & more

Aug 25, 2022

Good morning MIMs,

Before we dive into this week’s issue, remember that you don’t have to be a technical analysis maven or a meme trader snapping up garbage companies on the off chance to beat Wall Street.

All you have to do is put your money in the S&P 500, and guess what, you are crushing eight out 10 professional fund managers!

Who says there are no shortcuts when it comes to money, huh?

📈 Stocks

Clash of Oracles: JPMorgan Bulls vs. Morgan Stanley Bears

Introducing a new segment called Clash of Oracles where we’ll juxtapose bearish and bullish predictions from some of the most credible financial experts and dissect the thought process behind them.

After a while, we are going to look back on how these predictions fared. And, if they missed the mark, what possibly went wrong.

So, without further ado, welcome this week’s contenders.

On the bearish corner, we’ve got Morgan Stanley’s CIO Lisa Shalett who says this summer rally is an obvious “dead cat bounce.” She is coming up against JPMorgan’s bulls led by Marko Kolanovic who are convinced the worst is over.

🐻 Morgan Stanley: This Is Just Another Bear Market Rally

After the worst first-half in 50 years, stocks are having a blast this summer.

Since mid-June, the S&P 500 soared ~15%. Tech stocks fared even better. The tech-heavy Nasdaq jumped 23%, briefly tipping into a technical bull market, before pulling back this week.

Shalett believes the rally was somewhat warranted because back in June stocks were “near attractive levels.” At that time, the S&P 500 was trading at a forward P/E of 16, which was 16% cheaper than the pre-pandemic high in 2019.

Today’s valuations aren’t nearly as much of a bargain. In fact, considering a backdrop of troubles looming for the second half of this year, Shalett goes as far as calling stock prices “extreme.”

Here’s what keeps her up at night:

The Fed’s rate hikes are raising real interest rates, which will eat into an already low equity risk premium. In human language, it makes bonds more attractive against stocks. So in theory, stocks have to sell off to more tempting prices to compensate investors for the risk they are taking.

Here’s equity risk premium over the past 20 years:

The S&P 500’s earnings growth estimates, which come to ~10% for this year and 8% for 2023, may be way too optimistic considering the signs of a contracting economy all over the place.
Some of the red flags are falling purchasing manager indexes (PMI), with the leading indicator—the semiconductor book-to-bill ratio—back to pre-pandemic levels. That signals the post-Covid order glut is over.
The NAHB/Wells Fargo Housing Market Index (HMI), the key housing yardstick, is at the lowest level since 2008. Other economic activity gauges—such as orders to inventories or inventories to sales ratios—are also pointing to slowing industrial production.

There’s also the strongest dollar in 20 years, which makes American products more expensive and less competitive abroad. With ~30% of S&P 500 sales coming from overseas, a lot of companies are feeling a pinch.

For example, Netflix (NFLX) has reported that a strong dollar cost it $339 million in profits last quarter. Meanwhile, Johnson & Johnson (JNJ) and IBM estimate that the greenback can eat up $4 billion and $3.5 billion in sales this year.

Final verdict

“This summer's rally looks exactly like the other 23 bear

market rallies of the past 95 years.” - Lisa Shalett

🎯 Where the S&P 500 will be at the end of the year

3,900

🐂 JPMorgan: Peak Bearishness Is Over

JPMorgan’s Marco Kolanovic—who’s emerged as one of the earliest bulls in this cycle—sees things through slightly more rose-colored glasses. It all comes down to sentiment.

While Kolanovic acknowledges the risks, he thinks investors are more fearful than they should be. Inflation has peaked, the Fed's rate hikes will slow from here, and economic decline isn’t looking to be as bad as many thought.

Meanwhile, the market is still pricing in doom and gloom.

Case in point, here’s JPMorgan’s chart that shows how the market has exaggerated the risk of recession:

And how defensive investors still are:

That’s changing as Kolanovic sees the first signs that pessimism has peaked.

“The phase of bad data being interpreted as good is gaining traction, while the call of peak Federal Reserve hawkishness, peak yields and peak inflation is playing out,” he wrote in a note.

If investors ease up in the second half, stock valuations have much room to grow because, contrary to Shalett, Kolanovic thinks they still “look attractive, both in absolute terms and relative to fixed income.”

Final verdict:

“We continue to look for upside into year-end for a number of reasons: absolute and relative valuations, low positioning, overly bearish sentiment…” - Marco Kolanovic

🎯 Where the S&P 500 will be at the end of the year:

4,800

🚀 Digital Assets

What's Behind the Crypto Sell-Off? Jackson Hole and Liquidations

Crypto has been on one hell of a rollercoaster lately.

Since the end of July, the crypto market attracted $200 billion and grew to a total $1.2 trillion market cap—only to lose it all in the past few weeks. Last Friday alone, crypto shed 9% of its value, the biggest one-day drop in two months.

Not one major crypto dodged the blow.

In the past week, bitcoin retreated 7.1% to $21,700 after breaking through $25,000 on August 15. Following its worst week since July, ethereum continued the descent, falling 7.4% to $1,700.

Altcoins followed suit. XRP is down 7.5%, BNB 1.4%, solana 11.5%, cardano 13.3%, dogecoin 14.7%, shiba inu 10.7%, and Terra’s “luna 2.0” 8%.

What gives?

🔍 Zooming out

There’s one telltale sign that hints at the culprit of this flash crypto sale; it's that it all happened in sync with stocks—which indicates that crypto sell-off is a broader risk-off sale rather than a crypto-specific event.

The stock market has been chugging lower since last Wednesday when the Fed released minutes from the last FOMC meeting. The record revealed that Fed officials see “little evidence” of easing inflation and they are committed to taming it at all cost.

Remember that the Fed also dropped future guidance at its last meeting. That means Powell isn't going to “wink” at the market, suggesting what the Fed will do next, anymore.

The unknown is rattling investors who sold off stocks ahead of Jackson Hole where Powell is expected to give more clarity about what he’s up to.

Now, because crypto is still highly correlated to tech stocks and has higher beta, it simply amplified the moves we've seen in the Nasdaq, which has plunged 5.5% since last Wednesday.

For their part, leveraged crypto traders added fuel to the fire, too. According to Coinglass data, last Friday saw the biggest liquidation of crypto long positions on futures since June 18.

🔮 Looking ahead

All eyes are on Jackson Hole this coming Friday. Take note, because at this point, a single word out of Powell’s mouth can shuffle around hundreds of billions of dollars in any risk asset, including crypto.

🏛️ Macro

Here’s a quick bulletin of the most important macro developments in the past week

For the first time in two decades, the euro dipped below parity against the dollar over fears that Russia’s gas cut-off to Europe will stoke inflation, paralyze its economy, and send the continent into a deep recession. What could turn things around? A more hawkish ECB, because while the Fed hiked to 2.5%, the ECB has mustered just a single hike that brought rates to a mere zero. So, investors are naturally flocking to the more interest-bearing currency.

As PMI indexes show, Europe’s economic activity declines for the second month in a row as energy costs start to bite. Europe’s powerhouses, Germany and France, fell more than expected. Germany showed the biggest decline since mid -2020 and France unexpectedly contracted for the first time in one and a half years—all of which reaffirms that Europe is headed for a rough winter.

Meanwhile, US housing is sending mixed signals. Last month, pending home sales in the U.S. dropped to the lowest level in two years and home inventory grew to the highest level since 2009’s glut. Yet, despite drying up demand, median home prices have recovered, climbing to $439,400 last month after cooling down to $402,400 in June. Some economists take this divergence as a structural home shortage, which, contrary to the “repeat of 2008” calls, might keep a sturdy floor under home prices. Time will tell.

💬 Quotes MIMs Are Pondering

“Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

— Charlie Munger, vice chair of Berkshire Hathaway and Warren Buffet’s right-hand man.

Or as Buffet said himself: “The stock market is a device to transfer money from the impatient to the patient.”

Or as MIMs say, investing is an adult version of the Marshmallow test.

How many marshmallows have you got in your retirement portfolio? Leave a comment.

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