Thursday, January 14, 2021

It's Time For Minsky Asset Deflation

We've tried having a soaring stock market while the economy implodes - however most people were left behind. So now it's time to have a soaring economy while the stock market implodes. Try something different for a change...

One can make the case that the imaginary recovery is "priced in".

Wednesday night watching the futures I noticed that the Russell 2000 futures went vertical - deja vu of the vaccine news in November. Something was up. Now we learn that tonight after the close, Biden is planning to go big or go home:

"President-elect Joe Biden is expected to unveil a major Covid-19 relief package on Thursday (evening) and his advisers have recently told allies in Congress to expect a price tag in the ballpark of $2 trillion, according to two people briefed on the deliberations"

Biden's party believes it may have only a brief window to pass sweeping relief legislation and the President-elect has faced significant pressure from some Democrats to go big"

The following is a summary of the past several months of reflationary headlines:

Back in late August the Biden surge in the polls monkey hammered deflationary Tech stocks. Again in October when the Democrats looked liked they could win the House and Senate. And again in early November when the vaccine trials showed 95% efficacy. The Tech melt-up resumed in December during the winter COVID lockdown, however the rally was derailed again near the end of the month when the $900b stimulus was approved by Congress. 

What we notice via the chart below showing these events, is that the Tech/virtual economy bubble has been unstoppable despite many rotations to cyclicals. Now, since the beginning of 2021, both Tech and cyclicals are rising in tandem. It's the best of both worlds - an improving economy AND a massive stay-at-home Tech bubble. Someone is going to be wrong. Which means everyone is going to be wrong. Not only will the economy disappoint the cyclical stock buyers, but the Tech bubble will be final imploded by these constant rotations. The aptly named MAGA stocks (Microsoft, Apple, Google, Amazon), are no longer leading the rally. They have been underperforming the broader market since Biden surged in the polls back in September. Go figure. 

The Momentum Tech ETF which is underweight the MAGA caps has continued to outperform, despite several close encounters with implosion:

Semiconductors are at the happy intersection of Technology and cyclicals, therefore they go up every day regardless of which paradigm is in rally mode - reflation or deflation.

Semiconductors are now at the epicenter of every Tech bubble - Bitcoin mining, cloud internets, autonomous driving, artificial intelligence, video games, 5g wireless etc. etc. 

All of this U.S. stimulus has several implications for the EM trade. First off, it means the U.S. economy will outperform most of the world, and hence U.S. interest rates will be higher. Higher interest rates will boost the dollar at the expense of EM carry trades. In addition, the massive demand for capital by the U.S. government will crowd out Emerging Market credit. 

Here we see that EM currencies are diverging from EM stocks. 


The abiding belief since 2008 is that this expansion can continue forever as long as central banks hold interest rates at the zero bound. This delusion that central banks are in full control is well-entrenched throughout the economic establishment - only policy-makers control interest rates. Unfortunately, that is not actually true. Policy-makers can influence interest rates on a short-term basis, however, inflation expectations ultimately determine bond market values and hence interest rates. Bond markets are now starting to realize that this free money bonanza will lead to higher inflation, which is accelerating the end of cycle Minsky Moment. Per the Minsky Financial Instability Hypothesis, asset bubbles are imploded by higher interest rates. Whether those rates are due to policy-makers raising interest rates, or credit markets raising interest rates. It doesn't matter. To the extent that the Fed has given the U.S. Treasury carte blanche to issue new bonds, the Fed has now effectively ceded control of U.S. interest rates to the Democrats.

Nancy Pelosi may as well be the Fed chief now.

In 2020, the Fed monetized a $3 trillion deficit (15% of GDP). Which created human history's biggest asset bubble. This year, they are planning something even larger. We are now witnessing a ludicrous reach for risk at the end of the cycle in a pandemic depression. Something no one has ever tried before. For a reason.

Biden's election is the fifth wave blow-off top to the MAGA Tech rally which started four years ago. The same rally that gamblers believe just got started.