Hemingway’s seminal novel, The Sun Also Rises, does much to explain the human condition. It’s lessons can also be applied to markets[i]. Much literature and history does so but I have always found this novel to be poignant. This idea of using evidence from independent, unrelated sources or a “synthesis of knowledge” was propounded in The Unity of Knowledge by Edward O Wilson, who passed away in the last week of 2021. It also seems to have paralleled the advent of behavioral economics. While certainly not decrying statistics, data analysis, and various sciences as effective tools; I have always found literature and history to be additionally helpful. Conceivably that is an analogue to the behavioral element. The Sun Also Rises has long been a touchpoint for me in this matter.
On one occasion in the novel, while the characters carouse before the festival in Pamplona, Bill Gorton asks the Michael Campbell character, affianced to Lady Brett Ashley, how he became a bankrupt. His response is indicative of the dynamics of many phenomena including markets, and life itself.
Two ways, gradually then suddenly.
As I write this early in 2022, the quotation above describes a lot of what has happened in the past few weeks as the Omicron variant has emerged and the idea that global inflation is more persistent than previously hoped has transformed to a consensus. This does not refer to the January 5th sell off or anything following, the inflection I am referring to happened around November 26th. The transformation corresponded with the change in the inflation narrative, the advent of the Omicron variant, and perhaps the lowered probability of the Build Back Better Bill[ii] though this last point is debatable as the projected spending would have also accompanied higher taxes[iii].
That inflation is more entrenched, more insidious, and more lasting than at any time for most of us in our careers, and some of my younger colleagues’ lifetimes, shocked the markets after many months of data and anecdote indicating inflation was anything but transitory was universally ignored except by those of us curmudgeons who took umbrage with the word transitory. Simply put, what is driving the narrative in asset prices now is not new, but suddenly it matters. Things changed gradually, then suddenly.
Markets, investment selection, and capital budgeting tends to act in a Bayesian manner: each incremental piece of information, newly introduced, can change the thesis and Omicron and consensus inflation are the newest variables. The S&P only fell 4% peak to trough from the emergence of Omicron and acceptance of inflation while the Russell fell 8% though nearly 13% from its prior high in November. Moreover, the RVIX[iv] made a new high on December 1st reaching a level higher than any point in the past 10 years save the covid induced turmoil of 2020.
The 2’s/10’s spread had it’s biggest percentage movement in over a year on Friday the 26th of November though the spread had been higher at other times in the past year albeit from a differently shaped curve. Lastly, all this was accompanied by declines in meme stocks, SPACs, crypto and other listed speculative investments.[v] The part of this that people like me obsess over is not that this happened, or even that the regime changed quickly as that is common, but why at that point? Why did things that did not matter for so long suddenly matter? Equities have been richly valued for months, Bitcoin and Ether recently made new highs, Elon Musk continues to tweet whatever he likes at will, inflation expectations; measured by 5Y Break Evens; have even declined from recent highs. Obviously, risk appetite dissipated quickly but, again, why at that point? I suspect that if we were to collectively search our memories would suffer a recency bias; there were many points in the past year or more when things could have changed. Perhaps the confluence of factors was more influential than one thing alone. Asset prices rarely plummet when they are widely thought to be rich.
Odds and Sods
In a recent survey by the Dallas Fed, only 5% of the energy producing respondents indicated they believed countries would meet their commitments for 2030 to reduce greenhouse gas emissions. Interestingly, nearly half the surveyed energy firms have no plans to reduce greenhouse gas emissions in 2022 and only one third plan to reduce flaring of excess gas[vi] though the responses were heavily biased by firm size. One more anecdote indicating buy in from COP 26 is long way from being achieved.
Bluebell Capital has launched an activist campaign to convince Glencore to divest coal from their company. Bluebell’s thesis is straightforward: Glencore’s decision to hang onto coal until 2050 is “morally indefensible.”[vii] The only problem is, unlike last summer when another smaller fund, Engine No. 1, waged a successful activist campaign against Exxon Mobil, larger shareholders aren’t buying in. My cynical sense is that part of this likely is correlated with the performance of coal related equities. Worldwide demand for power continues unabated and restrictions on natural gas production coupled with higher prices, less nuclear power generation in developed countries, and reduction of hydropower in certain geographies has boosted coal. But there is an ESG argument to be made here: as desirable as reducing Greenhouse gases and transitioning to a less carbon dependent economy is, it will still take decades to achieve this goal thus, in the meantime, it is probably better for polluting assets to be in the hands of larger companies. Public companies are more likely to undertake responsibility to their stakeholders (in this case their communities and the residents of this planet) and not pass off their environmental costs as an externality. Smaller companies under less scrutiny may not be so inclined to uphold this responsibility. That private equity firms are now vying to take on dirty assets in a high commodity environment suggests that the incentive to manage these types of assets under less disclosure is alive and well. Many sustainable investment funds have neatly sidestepped this issue by deftly, and pragmatically, arguing that owning the best of breed in least desirable spaces is still congruent with sustainability.
Opinions are expressed are solely my own. Any investments mentioned do not constitute a recommendation to buy or sell anything. If you do act on the opinions of errant writings without doing your own research you might consider talking to an investment advisor, a psychologist, foregoing that third drink or reexamining your decision-making process. I do cite sources and use end notes but amidst other responsibilities and foci I apologize for any inadvertent plagiarism or regurgitation of other’s ideas though we all know that true originality is a rare commodity - Marcel Duchamp's dictum applies. If you disagree with my content or opinion don’t read it.
[i] Those who know me will recognize this thesis. I reserve the right to use it repeatedly, exhaustively, and annoyingly to the end of my days.
[ii] I belive many of my classmates in my first year marketing class could have coined better terms then that alliteration laden moniker, let alone the creatives who went into brand consultancy.
[iii] Not looking to debate BBB or tax policy on the merits here. Just conveying the general equity market view.
[iv] CBOE Russell 2000 Volatility Index
[v] I am unaware of any NFT Index at this time though I am confident one will be developed anon.
[vi] DallasFed Energy Survey Fourth Quarter 2021. Larger firms, which tend to be more environmentally compliant, surveyed far greater willingness than smaller firms.
[vii] The Economist, Glencore’s message to the World. December 31, 2021
