The guest commentary below was written by written by Mitchel Krause. This piece does not necessarily reflect the opinions of Hedgeye.
For better or worse, I don’t drink, do drugs or smoke. My consumption of processed sugar these days is at an all-time low and my shopping is pretty much limited to necessities. More importantly, I don’t gamble … If I’m addicted to anything it’s my process and discipline.
A clear mind paves the way for better decision making, which again, pertains to all facets of life – especially when applying process and discipline to our work. Those close to me would likely suggest my work might be an addiction (second only to my family)! I’d liken it more to an obsession/passion, as I attempt to be keenly aware as to not let it drown out the beauty of life, but managing risk is a very serious business.
Waking up at before dawn (5 a.m.) daily and working through the global macro data has become routine. However, when conditions like those we’re currently experiencing arise, our addiction or resolve to make sure we’re on the proper path only grows stronger.
Markets are addicted to liquidity
It is their preferred drug of choice. They crave it, have no control over it and don’t care about or even understand the severe consequences tied to it! And while the Treasury Secretary might be able to temporarily influence flows when draining $700 billion from the Treasury General Account (TGA), that doesn’t FIX the data, economic cycle or remove gravity from the equation.
With the resolution of the debt ceiling and refilling of the TGA underway, as we described last month, liquidity is once again ROLLING OVER.
It’s important to remember, while “flows” can and will impact markets in shorter-term intervals (weeks to months), in the end, the macro cycle and data has been undefeated; it’s where our odds are the best, which is the very reason the data is at the core of our process and discipline.
The vast majority of the world is addicted to spending
Much of this is accomplished via the accumulation and rolling of debt. We’ve been mapping this out for 18+ months now. Household balance sheets are deplorable, credit and debt has grown to all time highs, as real wages when adjusted for inflation have shrunk for the past 26 months now.
Lending has grinded to a virtual halt while at the same time, savings have been depleted pushing consumers to max out credit cards (with borrowings at all-time highs), coupled with average yields on credit cards also at all-time highs as are interest rates on car loans and corporate/government debt.
The amount of wasteful spending across the board is incalculable and when liquidity is plentiful, it matters, but much less then when liquidity is sucked from the system like a massive vacuum, which is happening as the TGA refill is draining liquidity from the system and global central banks are shrinking their balance sheets as they continue to turn the screws on borrowers.
This squeeze is hitting consumers and businesses alike, which is crushing personal and corporate balance sheets. Retail sales are abysmal, industrial production (recessionary), capex spending is in the tank, manufacturing is in recession globally, corrugated box sales are plummeting and GDP is heading to 0.
This decelerating economic road leads to an acceleration in bankruptcies (which are spiking) and layoffs (which have troughed), which reduces the passive bids from the system as both 401(k) contributions and corporate buybacks dry up. Just another example of more liquidity being drained from the system as the cycle marches on.
We stick with the data
In the end, over the course of time (history), it’s undefeated. We won’t always be right in the short term, but historically, we have largely side-stepped the largest of recent market declines.
The process we’re following today is the very same process that protected us when the majority of Wall Street got absolutely smoked. We have no bias as to whether we’re fully long, partially short, or mostly in cash. The data and process dictates this, and based on the history and the data, the odds remain in our favor than most understand.
A longtime client recently asked, “Why do most investors never see ‘it’ coming?” My response, right or wrong, is that most focus on shorter-term price action vs. the data.
Given all of the data we look at daily, we find it troubling the majority of financial professionals are investing clients as aggressively as they are while claiming to be “fiduciaries.” “But we’re up year to date,” isn’t a risk management process, especially when they got crushed last year. What will they say when markets go limit down for consecutive days and weeks, as is often what happens during credit events?
People crave their addiction; they lose control and continue to participate despite the consequences! “More” isn’t always better. Neither are extremes when it comes to markets.
Virtually everything we’ve laid out over the past year and a half is lining up exactly as we said it would. We question how any investment professional who considers themselves a fiduciary could chase markets led by seven names while willfully ignoring the copious amounts of data and history.
The addict wants MORE, then people wonder how she or he could have possibly overdosed. The gambler doesn’t want to miss out (and then wonder why they’ve just gotten crushed with many hedge fund managers crying on TV).
Please exercise some patience. As we noted last month, we’ve seen this story play out multiple times throughout our career: Over-confidence in the belief that we have the “all clear” in markets due to the price action in a few names that are holding up two broader indices. This can and often does lead to significant pain when liquidity games can no longer be played, and economic gravity becomes reality.
We don’t know the exact day when, but given the data, history and liquidity setups, it is our opinion that the addicts are about to have a very bad day … we suggest proper investors prepare accordingly!
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Click here to read Mitchel's note in its entirety on the Other Side Asset Management website. |
ABOUT MITCHEL
This is a Hedgeye guest contributor piece written by Mitchel Krause and reposted from his most recent monthly report. Krause is an industry veteran of nearly 28 years, where he’s seen the industry from the inside out. Nearly a decade of private wealth service, followed by just under seven years with an institutional group focused on banks and thrift stocks. He’s been managing discretionary money since 2015. His career began at, Ryan, Beck & Company in 1996, a boutique firm specializing in financials and municipal bonds, which was later bought by Stifel Financial Corp in 2007. He opened the doors to Other Side Asset Management in 2018 in an effort to tell the “other side” of the investing story to those willing to listen. He continues to manage discretionary assets while publishing these notes monthly. His archives are open to the public. Currently, he both works and resides in Raleigh, North Carolina.
Twitter handle: @OtherSide_AM
LinkedIn: Mitchel Krause
