“Well, that escalated quickly!” Ron Burgundy, Anchorman

The biggest news over the last two weeks has been the US Federal Reserve (their Central Bank) finally coming around to the realisation that inflation is here, now, and is having an impact. Like Ron Burgundy in the quote above, they seem to not be reading and/ or seeing the same signs that most market participants felt were very obvious. I don’t want to do too much of a victory dance, though being correct in difficult markets should be celebrated – I’ll make do with a small fist pump – but it was fairly obvious to the woman/ man on the street that prices were and are still increasing.

This also reinforces my long-held position that academics, scientific advisors and government employees should actually open their eyes and join the real world occasionally to see how the rest of us have to actually live our lives.

This was no different in the UK either, with Bank of England governor, Andrew Bailey, guiding for an interest rate increase at the last Monetary Policy Committee meeting, only to disappoint on the day. Rather harshly, the media referred to Andrew Bailey as the “unreliable boyfriend”… not my quote, but rather amusing nonetheless.

What is less amusing is now the Bank of England has lost credibility and is seen as out of touch with the UK economy, with potentially the emergence of the Omicron variant saving its blushes. Let’s see how this plays out, but put simply, Omicron or no Omicron, interest rates are going up before they go down, and they could go up quite quickly.

US Technology leads global sell-off

The other major event over the last week has been the melt-down of a number of US technology shares which led to a global sell-off at the end of last week. The main indices are actually holding up ok, but the previous tech darlings of the investment world have come under sustained selling pressure. Why? For those that remember my previous writings on what moves markets, it’s our two old friends again – liquidity and positioning. For any new readers, if you want to read my original thesis, please message me directly.

How bad has it been?

• >50% of stocks in correction or bear territory (meaning at least 10% off highs)
• Meme stocks crushed. AMC/ GameStop holding up but 60% off high
• Nearly all crypto in a bear market and even Bitcoin down 40%, but some still strong YTD
• Oil down 30% from the peak

Yet, fortunately, most people haven’t realised or felt this, because the larger stocks and indices have held up relatively well – for now.

So what is happening?

Back to liquidity and positioning again. Liquidity will begin to come out of the US investment markets in December.

Let’s look at liquidity first as this is the easy one. The US Federal Reserve is currently buying $120 billion (yes, billion) government bonds every month – $80b in Treasury debt and £40b in mortgage-backed securities.

The reason they do this is to keep bonds prices high which keeps the yields (or interest rate) low. The theory is a low benchmark interest rate allows companies to borrow and re-finance at relatively low levels and stimulates the economy. What ends up happening is a lot of that money gets pumped straight into the stock market and keeps stock prices high as well. Still with me? It’s like driving a car with the choke out (for all those that remember those things!)

Ok, so the change that has been announced is the US Federal Reserve has agreed to reduce and potentially stop these bond purchases, because:

a) they have realised that its inflationary – see above

b) they think the economy is in strong enough shape not to need it.

They will start doing this in December which means liquidity being removed from the market, hence selling shares. Can it be that simple? Not always, but sometimes with hindsight it can be.

Positioning was extremely bullish

The other factor is positioning. There is a seasonal effect here as traditionally December is a very good month for markets, especially when the market has had a good year. The main reason given for this is funds need to participate in the market and show they are holding winning positions at year-end close. Strange yes, but it has tended to work over the years.

The other factor is highlighted by the tweet sent by Sentiment Trader:

All aboard a derailed train.

This week, speculators in major equity index futures bought aggressively, moving to a net long position of over $100 billion.

That’s nearly twice as large as any other position extreme, in either direction, ever. pic.twitter.com/0XNJCQ19vc

— SentimenTrader (@sentimentrader) December 3, 2021

This chart was actually dated Tuesday 30 November and would have definitely reduced after the last few days of selling. But, the point is, investors were positioned VERY long equity futures. This extreme positioning, be it either bullish or bearish, tends to generate a turning point in the other direction. Welcome to the stock market.

How long this lasts is anyone’s guess. The main change to highlight though is with this liquidity being reduced from the US market, we can most probably expect to go back to normalised average returns at best, unlike the brilliant performance many investors have had in 2021.

So what does this mean? I’m talking average 3yr+ performance of Cautious funds +2% to +5%, Balanced +3% to +6%, and the overall equity market +7% to +10%. Not terrible, just back in line with historical averages.

I hope you are all enjoying a minced pie or two – I certainly am… as my waistline can testify.

As ever, happy to respond to any questions.

Adam.

Adam Walkom
Permanent Wealth Partners
Phone 020 3928 0950
Email adam@permanentwealth.co.uk
LinkedIn www.linkedin.com/in/adamgwalkom