2022. The Banquet Of Consequences.

December 2, 2021

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Total Enterprise Value of Firms with EBIT Less Than Interest Expense Chart

Sooner or later, we all sit at the banquet of our consequences.” 

Robert Louis Stevenson

2022 will be a banquet of consequences.

A rising rate of change in both growth and inflation (quad 2),  in place for most of 2021, has ended. The outlook is some combination of “goldilocks” (quad 1) or “deflation” (quad 4). Make sure your allocation is shifting appropriately.

2021 was a massive reflation year (quad 2) following record  policy intervention starting in March 2020. However,  in rate of change terms, 2022 will very likely show the first significant decline in growth and/or inflation since the Covid “stimulus” was implemented.

Problems can be swept away when growth is accelerating. Typically junk bonds perform well along with the most speculative assets. However, this all changes when the rate of change of growth and inflation turns down. What will happen then? How robust and durable has the “recovery” been?

Financial Potemkin Village.

Never before has intervention taken on the scale of what has happened since March 2020. This introduced unprecended and extreme reactions in the economy and markets.

The header chart shows that if you just bought negative earning stocks, on avearge, you could have tripled your money.

“The chart above shows that despite record low-interest rates, the market cap of firms that cannot afford to pay their interest expenses has never been higher.”

When quad 2 ends you should expect zombie companies to have a different reaction.

The chart below shows how much zombie companies outperformed the S&P500.

AMC, AMC Foolishness Comes At A Dear Cost

The AMC story in the link above shows how much asset prices have become clearly distorted. Yield and return starved investors are searching for somewhere to go,  and with record excess liquidity, corporations and Wall Street have a solution.

“The issuance of junk bonds and leveraged loans soared to $1.02 trillion in 2021 through November 12, beating by far the full-year record established in 2017 ($780 billion), “as speculative-rated companies have amassed cheap funding from yield-hungry investors,” according to S&P Global Market Intelligence.

Within the S&P 500 distortions have been driven by cash flows and passive investing into ultra big cap stocks. As shown below, the five biggest stocks got even bigger to a new all time record percentage of the S&P 500. With QE and Buybacks providing well over 2 Trillion of asset purchases in 2021 alone, the largest companies had to outperfrom to adequately accomodate the record level of excessive liquidity.

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No US equity index properly describes all the distortions in US equity performance in 2021

SoMeme” stocks, like AMC, ultra big cap stocks and zombie stocks, all had spectacular performances which were far beyond their earnings. At least until the oil price collapse in recent days which ended quad 2 reflation.

Most stocks peaked in just the first 2 months of the year. The performance more broadly has been very uneven. IWO, the Russell 2000 growth stock ETF, peaked in the first week of February, 2021. So much for a year long rally in US domestic growth stocks, IWO has been declining since February!

Furthermore, the chart below shows that the peak in the percentage of NYSE stocks trading above their 200 day moving average was also in the first 2 months.and has weakened ever since and remains in a downtrend. Around half of NYSE stocks are already in a confirmed downtrend on this simple measure.

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A motherlode of simultaneous historical indications of a market peak.

“Well, on Friday, November 19, we hit the motherlode. Across four decades of work in the financial markets, and over a century of historical data, I’ve never observed as many historical indications of a market peak occurring simultaneously.”

Motherlode – Hussman Funds

Durable and transient S&P 500 returns (Hussman)

Here and now, market conditions are characterized by:

  1. The most extreme valuations in U.S. history, on the measures we find best-correlated with actual subsequent market returns over the past century, and even in recent decades, coupled with lopsided bullish sentiment and historic levels of margin leverage;
  2. Deterioration and divergence across measures of market internals that we believe to be reliable gauges of investor psychology toward speculation versus risk-aversion;
  3. The largest preponderance of overextended syndromes – typically associated with intermediate or cyclical market peaks – that we’ve ever observed in history.

Not a forecast. Not a “limit.” Not a market call. Just sharing what we’re seeing.

Still, it’s fair to add that we’ve never seen such a thing.

In general, current risk assessments, positions and behaviour reflect a lack of prepartion for the scale of mean reversion from market distortions and the inevitable unwinding of extreme allocations.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

It is crucial that investors review their risk management and investment allocation process. For more information, find out what the Best Investors do: https://chrisbelchamber.com/.

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