FOMO, POMO, and the Fleeting Sigh of Relief
This week the S&P 500 notched another record weekly close. It even managed to breach and hold above the psychologically significant 5,000 level for the first time in history. Make no mistake, after an epic 15-week 22% rally into blue-sky record territory, the stock market’s partying like it’s 1999.
Fed Chair Powell’s underlying de facto message to markets has been that the Fed will restore Goldilocks economic conditions “unconditionally.” That message is working. Powell’s assurances have been more than enough to allow Wall Street to set up the ongoing “trust-me” trade higher in financial assets.
With inflation measures to date having fallen substantially from peak, the Fed seemingly close to initiating a policy easing cycle, and the GDP economy “booming,” stocks are—again—all the rage.
Fear of missing out (FOMO) has officially turned into panic of missing out (POMO), and now with the S&P over 5,000, the Goldilocks trust-me trade looks utterly bulletproof to many.
But HAI doesn’t believe Goldilocks as we’ve known it is coming back at all. The trust-me trade looks overly consensus, overly extended, overbought, and overestimated.
In short, the current trust-me dynamic is good for a trade higher in financial assets, but unless the narrative of easier policy and inflation lessening to target is actualized, the trade will eventually fail.
Data this week furthered HAI‘s expectation that the inflation variable in the Goldilocks equation will be sacrificed and turn non-cooperative first.
On Wednesday, the US Energy Information Administration cast doubt on the outlook for US oil production growth. Again, recall that over the last decade U.S. shale has been responsible for roughly 90% of all global supply growth. That said, however, Permian and Eagle Ford shale recoveries have both fallen by 30%, and the Bakken has declined by almost 20% from peak. Combined, those shale plays accounted for two thirds of U.S. oil output in 2023.
To keep production growing despite burgeoning decline rates, the shale industry needs to constantly ramp-up capital expenditures. But as energy analyst James West at Evercore ISI said several weeks ago, expectations are now that industry cap-ex will be flat in 2024.
This week, the EIA seemed to confirm that bearish outlook on U.S. production. In its monthly Short-term Energy Outlook, the EIA said it did not expect that U.S. production rates reached in December 2023 will be exceeded until February 2025.
That’s important because OPEC+, currently keeping 2.2 million barrels per day off the market, still expects non-OPEC supply in 2024 to rise by 1.34 million barrels per day, with nearly half the increase coming from the U.S. If OPEC+ continues to keep barrels off market and U.S. production growth disappoints, then, unless we have a significant recessionary hit to demand, oil supply/demand fundamentals could meaningfully tighten in 2024.
Meanwhile, in the face of this potential for tighter supply, Saxo Bank is getting more bullish on demand. According to Ole Hanson, Saxo’s head of commodity strategy, with Beijing now stepping up efforts to support the Chinese economy, “global demand is expected to rise around 1.5 million barrels per day” in 2024. Tighter supply on rising demand could certainly set the stage for a consequential rally in crude prices. Recall, energy prices are the great inflation force multiplier. If inflation remains stubbornly elevated today despite energy prices having offered a disinflationary tailwind, expect a significant reacceleration higher in the CPI when energy prices rebound.
Meanwhile, the supply-side picture in copper is even worse. At the end of January, copper behemoth Codelco, a company responsible for 7% of global supply, said its annual production was the lowest in the last quarter century. More alarmingly, the company said it will take six years to reach its prior production peak of 1.7 million tons in 2018. The message out of Codelco is clear. Unless copper prices move a lot higher, there will be significant supply problems going forward.
Again, if the Chinese economy can get some traction from ramped-up government stimulus measures, and U.S. demand picks up as the copper transmission lines in the Inflation Reduction Act get built, then tightening supply/demand fundamentals could stoke a significant rally in copper. If both oil and copper begin to head higher together, expect the CPI inflation data to get nasty—and quick.
Additionally concerning for the inflation fight was the latest bank Senior Loan Officer Opinion Survey data (SLOOS). The latest update showed that after peaking at more than 65% of loan officers tightening lending standards last year, the number has now dropped to less than 20%. Over the past 30 years, whenever that number has fallen under 20%, CPI inflation readings have bottomed out and then started rising.
Again, Powell’s trust-me trade higher in financial assets requires that inflation play nice. If the script gets flipped, oil and copper prices both get moving to the upside, senior loan officers loosen lending, and inflation transitions from friend to foe as an emergent 2024 problem, then make no mistake, the party on Wall Street comes under serious threat.
What’s the risk to financial assets at today’s price levels? According to the work of legendary market analyst John Hussman, the risk is severe. The trust-me trade could become the “pain trade” in a hurry.
Hussman—who predicted the 2000 and 2008 market downturns—is warning investors of another major fallout coming in stocks. Citing his “most reliable valuation measures,” Hussman said stocks appear the most overvalued since the prior peak in 2021 and the five weeks surrounding the turn of the new year—in 1929.
As Hussman put it, “it’s fair to say that we would not be surprised by a near-term market loss on the order of 10% or more in the S&P 500, nor would we be surprised by a full-cycle market loss on the order of 50-65%…” He continued, “We estimate that current market conditions now ‘cluster’ among the worst 0.1% instances in history—more similar to major market peaks and dissimilar to major market lows than 99.9% of all post-war periods.”
In conclusion, Hussman said, “My impression is that investors feel an almost excruciating ‘fear of missing out’ amid nominal record highs in the S&P 500 and Nasdaq 100, enthusiasm about an economic ‘soft landing,’ and an expected ‘pivot’ to lowering interest rates.” “In my view, abandoning systematic investment discipline amid the most extreme market conditions in history would be a costly way to buy a fleeting sigh of relief.” HAI couldn’t agree more. The sand in the hourglass is running out on Goldilocks conditions. When that time comes, it’s the regime-change assets in the hard asset universe with deep value characteristics that seem poised to benefit most from a new era of new pricing.
Weekly performance: The S&P 500 gained 1.37%. Gold lost 0.73%, silver was lower by 0.92%, platinum lost 2.60%, and palladium was crushed by 8.40%. The HUI gold miners index was down 3.74%. The IFRA iShares US Infrastructure ETF was down 0.72%. Energy commodities were volatile and mixed on the week. WTI crude oil gained 6.31%, while natural gas was hammered lower, down another 11.16%. The CRB Commodity Index was up 2.47%, and copper dropped 3.66%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 0.21%. The Vanguard Utilities ETF was down 1.82%. The dollar index was up 0.20% to close the week at 103.99. The yield on the 10-yr U.S. Treasury jumped by 14 bps to close at 4.17%.
Have a wonderful weekend!
Investment Strategist & Co-Portfolio Manager