Crosscurrents, Shocks, Surprises, Murkiness, Confusion And So On

100 us dollar bill

Photo by Frederick Warren on Unsplash

One of the more amusing aspects of what happens when you move into historically unusual circumstances is how people react to it, and demonstrate that they have very little understanding of what they are dealing with. This is what happens when you get used to stability, and, as with anything in the human experience you get used to, eventually take it for granted. You simply don’t realize what you’ve had going for you, and you have very little idea the shocks you are about to be subjected to that are all new,  and how they will rock your world to the core.

A term that was widely (mis)used in the dot com era, leading up to the crash that ushered in the new millennium, was visibility. Visibility this, visibility that, and why was this word so popular? It was popular because dot com stocks led by AOL (VZ) were going up, up, up and didn’t have any earnings to back up the soaring stock prices. So people would say “yes, visibility is an issue” and this was a vague way of saying “at some point in the future these companies will have earnings that will justify the stock market as a discounting mechanism demonstrating how important and revolutionary connectivity technology is to our world, our economy, our lifestyle.”

In other words, pure BS to camouflage a bubble.

One of my favorites back then was this dramatic web site sales pitch: “what the technology revolution is teaching us is that there will be two kinds of companies from now on: those with websites, and those that go out of business.”

By Unknown author - Johann Lund, Die alten jüdischen Heiligthümer., p. 564, Public Domain,

18th century depiction of the Moloch idol (Der Götze Moloch mit 7 Räumen oder Capellen;
"The idol Moloch with seven chambers or chapels"), from Johann Lund's Die Alten Jüdischen Heiligthümer (1711, 1738).

You should have seen the grim looks that took over rooms full of faces when these ominous words were uttered. “Technology,” throughout the 1990s up to the 2001 crumbling was the big bad boogeyman (Moloch) in the room. You couldn’t get out of the way. Nothing was bigger. Your future was conscripted by it and you had to adapt and conform or else. And for both retail and institutional stock buys this meant buy buy buy tech and especially dot com or die. How did this end? With folks like Bernie Ebbers, WorldCom and various other sad stories.

So that was the spiel known as visibility two decades ago.

The REAL Visibility Issue

Back in more innocent times, life was so boring we had to make up stuff to substitute for trouble, and one of those things was a genre of humor known as “elephant jokes.” I’m reminded of this pastime because kids really loved elephant jokes and today, with the phrase “the elephant in the room” so vastly overused, it occurs to me that everything is an elephant in the room. But just because almost every single thing is radically damaged or hanging by a thread doesn’t mean that. Because relatively speaking, these things being in all the same condition of weakness means none of them are to worry about because they’re all equally dangerous. Rather, it means we are in big trouble with many trouble zones, including war and heavy warmongering—never a good thing. The biggest of these factors is inflation and surrounding issues like debt that make taming inflation virtually impossible. Lack of inflation is the biggest thing we have taken for granted. It has fueled equity and credit market valuation explosions over the past three or four decades. It has given us P/E multiples in the 40s and higher, for the stocks with the biggest caps responsible for soaring market weighted averages. Back in the 1970s when inflation really started biting our butts hard, those multiples came down to single digits. This is the kind of radical pricing adjustment that would bring the S&P 500 down below 1,000 were it to happen now.

So the elephant joke I’m thinking of is “Hey Mom, there’s forty or fifty elephants milling around the front yard like a bunch of cafones in a Jersey shopping mall.” “No problem,” Mom replies. “Just take Dad’s binoculars, turn them around and look at the elephants backwards. Then use my tweezers and pick them up and put them in a milk bottle.”

Wouldn’t it be nice if problems were that easy to solve?

Before the tech revolution took hold, beginning with the PC and spreadsheet software in the 1970s and 1980s, you could go back to World War II and the consistent top performer in both bull and bear markets was energy. Giant large scale integrated oils. Whether in the booming fifties and sixties or the moribund 1970s, if you had simply purchased good old Standard Oil right up through the end of the century, you didn’t need to do anything else; your outperformance would have been no less than magnificent. And with big dividend payouts.

The big issue economically was inflation, and that’s why big integrated oil was integrated. When supplies upstream were expensive, the earnings benefited from that, and when they weren’t, margins downstream at the pump benefited from that. So you could slide up and down the oil barrel price curve like the roller coaster at Lake Compounce and win either way. What was the big energy discussion and worry? “We’re running out of oil and dependent on nasty OPEC gougers.” And what did our multi-decade education on that issue teach us to do now, accentuated by “green concerns?” That’s right…strip mine lithium, which is located in places controlled by folks like the Taliban, and worse. And also become dependent on the whims of bloodthirsty tyrants in places like DR Congo for strategic minerals because, after all, that’s MUCH better than dealing with the Saudis, right?

But inflation is even worse than that because it’s always there and it doesn’t matter if you’re at war, enjoying peace or whatever. It cuts into margins and, even more dangerous and insidious, it’s wildly unpredictable and varies from thing to thing and place to place. It even hurts oil companies, which is why they’re integrated.

Nobody likes uncertainty

The main thing about an inflationary era that drives multiples down is uncertainty and the only way to discount the diminished probability of forecasted outcomes being reliable is to downward price. Why? Because of what the retail sector is demonstrating. Margins get killed and the process sneaks up on you like a stealthy ninja.

Two main players are in this game, the corporate CFO and the analyst who is trying to pick up on the clues the CFO is providing from guidance and translate that to a forecast and a price target. This is when it is discovered how precious lack of inflation was and why you shouldn’t have taken it for granted.

It’s not that oil will be $145, or that it will be $85. It’s that you don’t know what the price will be. So you can have wild surprises on your cost factors, your hedging and very volatile swings in outcomes. And then one day you have to report the quarter and you see what a folly all the “guidance” is, and your stock is taken out back and shot. Like Target (T) the other day.

Then there’s a thousand other price inputs you also can’t predict reliably any more, just like oil.

And by the way, it’s not just that oil is really expensive now, which it is. But just two years ago it was trading at a minus number, during April of 2020. Do you remember that? Now that’s volatility. One of my biggest fears is that we are seeing insane fluctuations like this more and more frequently, in a growing number of places and things, and not just prices but in geopolitics, policies and various kinds of once stable human behavior…such as what it is like to live in a major metropolitan area today.

This is What the RLH Volatility Model Sees as Inflation Dominates the New Reality for Markets

  1. Retail. The model was already in pain mode and short before it paid.
  1. Staples. The model likes staples but that sector got spanked last week. Is a bounce coming?
  1. Utilities. The model is short utilities. The knee-jerk on this: “rates to rise.” But I think it’s actually more complicated and means there will be big drama in anything interest rate sensitive as the world discovers what to me is the very obvious reality that the Fed is totally hamstrung in its ability either to raise rates or to let the balance sheet(s) roll off.
  1. SPX. General index runs are topping and rolling over.
  1. Financials. Bullish. I am confident this is dead cat bounce stuff. Buffett is grabbing up Citi (C) with both hands but remember that issue is still down gigantically from its pre-mortgage meltdown peaks. “Quality” in this sector is JPM but the model thinks that stock is shaky
  2. Materials.  Bearish.  This is plain vanilla obvious to me that cost inputs will go head to head with recessionary headwinds.  This will ripple through everything industrial and related.  And when you have both bearish retail and industrial sectors, you have economy-wide trouble.
  3. Energy. Bullish. No surprise there and no explanation needed. The heart of the economy. Russia has secured its market with Europe, Biden has capitulated on oil and Putin has cordoned off the Ukrainian harvest in storage. This is very serious stuff, as people tend to view food on the table and heating their homes as very serious matters.
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Harry Goldstein 2 years ago Member's comment

Entertaining article, but that has to be the worst "elephant joke" I ever heard!

Reid Holloway 2 years ago Contributor's comment

harry, financial stand-up is a tough racket.  shakespeare could take the dead cats and rotten food they threw at him at stratford-on-avon, and my skin is pretty thick.  just don't do a will smith on me.  and thanks for reading.  --reid.