Squirrelly Thoughts, Duckies & Paul Tudor Jones

May 5, 2022

“BRO!!”

It’s what I yelled.

“BRO!!” Because apparently that’s what you yell at a squirrel when he’s stealing avocados in your backyard?! lol

Amazingly “BRO!” is what I settled on after hearing “thunk, Thunk, THUNK!” as the little munchkin grabbed, tasted, and then tossed from on high the 99% of perfectly fine avocados he deemed unworthy of his fine palate.

Ya little furry food critic.

Right after I declared our brotherhood . . . he stared at me. Beady little eyes. I see you, I know you see me. Time freezes and we share a moment.

Let’s chilllllll with the tasting okay? At least eat the whole thing will ya? Yeah you understand, I know you do.

Okay good, we’re good now. With the detente, I turn away . . . walk back into the house.

Thunk!

Grrrrrrr.

Then it hit me.  Maybe he’s trying to get my attention. Of course!

He’s obviously been trying to get my attention to pay attention. No doubt he’s been listening to the Paul Tudor Jones (“PTJ”) interview I’ve been streaming on CNBC.  PTJ, for those who don’t know, is a famous investor who accurately predicted and profited from the 1987 stock market crash, and has in the three decades since become an industry titan.  Featured in Sebastian Mallaby’s seminal book, More Money Than God, he’s a force to be reckoned with and one to pay attention to whenever he speaks. 

His clarity of thought is always impressive and the level of insights terrific.  Now many investors, when interviewed, will talk their book. They’ll talk about or allude to positions they hold, and you can plainly see that they have ulterior motives. PTJ, and a few other folks like Druckenmiller, however, are so good that they can tell you their unvarnished thoughts in the moment . . . and they’ll still crush you.  They’ll pivot faster, change their minds quicker, or simply make better decisions than you.  They have more information, better access, a stronger constitution, and smarter people. Period. To think otherwise is foolish.  Whatever the reason, it’s akin to Jordan telling you what he’s going to do and you being powerless to stop it.  So pay attention when they share their views.  It’s not 100% certain nor unbiased, but it’s sure insightful.

Even a squirrel knows that.

So with that, let’s go through three points in the interview our furry friend thought were important, the three things PTJ is currently . . . thunking.

Things he thunk #1 The Market

“If you look at how much financial conditions index has tightened in the last month, …it’s moved so much in the last month, the only other two times its exceed is Lehman Brothers in 2008, as well as March 2020.

’81/82, right after the crash of ‘87, right after 9/11, I think twice in 2002 towards the bottom of the bear market, and then three times in 2008 and then March of 2020 during the pandemic . . . every one of those instances were all associated with cuts, Federal Reserve board cuts, within 24 days on average, literally some of them within 2 or 3 days.  Now all of a sudden we’ve got the same kind of reaction with the market, which is of clearly a risk off, credit spreads have blown out, stocks are down 13% for the year, the dollar is up significantly, all that normally has provoked or evoked a Fed response of cutting rates, and yet we’re probably on the cusp of 200 basis points of rises in rates by mid-September.  It’s uncharted territory is where we’re going.

Clearly you don’t want to own bonds and stocks, it’s going to be a very negative situation for either one of those asset classes.  You can’t think of a worst macro environment than where we are right now for financial assets.”

So a quick aside on financial conditions indices.  They’re a proxy for the economy. FCIs are a composite of the dollar, stock market, credit spreads, etc.  Here’s an explainer I highly recommend from MacroTourist that illuminates the topic. There are many FCI’s out there, but many of them show the same things. Below is the Goldman Sachs FCI, and you can see how noticeably tighter (the higher the index, the tighter the conditions) financial conditions have become in the past few months.

For PTJ, his bearishness comes down to a simple reason, against the tightening financial conditions (i.e., less liquidity) the level of overvaluation in stocks and bonds (i.e., because of the low rates) is a serious serious concern. This is pretty self-explanatory. If there’s a ton of water in the bathtub (i.e., money/credit, “loose financial conditions”), then all of the rubber duckies (i.e., assets, stocks, bonds, real estate prices) rise.

You take away the water (i.e., begin quantitative tightening, increase interest rates, etc. because inflation is getting out of hand) then what happens to the duckies?

With the S&P 500 estimated to generate an earnings yield of 5% this year and next, how does that make any sense in the context of interest rates doing this?

Mind you this chart is as of Wednesday.  As we write this, the market is down 3%, merely giving back the ferocious rally we had Wednesday, but in all honesty, likely to go lower given positioning and sentiment.  Bull markets die hard, but with financial conditions tightening as severely as they are, and at such a quick pace (i.e., the more important factor, rate of change), sentiment can quickly follow.  So beware.

Things he thunk #2 Oil

“I was at dinner last night, with the head of a really big conglomerate in the States, and they’re known as an energy company, but they have just a multitude of investments, then he made two  really important points, one was they’re not investing in energy, because the ESG concerns are so great that it just makes them want to stay away from that space. and they can’t get credit because banks don’t want to fund that because of ESG concerns well I thought that was very telling and it makes me a lot more constructive on oil and commodities than I was before I hear that.”

Any guesses as to what oil company?  We’ve a few, but does it matter?  This isn’t something we don’t know as we’ve discussed the dearth of capital and the ESG issues at length.  Nonetheless, this isn’t something that’s widely known.  We only know about it because our thesis has centered around energy for so long, so we’re deeeeeeeeeep into this topic.  Thus, it’s unsurprising, and still a bit revealing that this anecdote is being passed along as revelatory. 

We can see it in the data though.  As many fret about oil demand, the reality is that the other side of the ledger, oil supplies and inventories, are shrinking fast.  Contrary to the popular opinion that oil supplies will come online to save us (from somewhere . . . where?), the reality for analysts who’re in the weeds on this thesis is that there’s only a few things that can arrest the slide, but those options are dwindling by the day.  So what starts as an anecdote from a dinner conversation will become common knowledge at a cocktail party.  News of a shortage is spreading, and it will continue to do so, until we all look-up and wonder . . . how did we get here?

Things he thunk #3 Hysteresis

“. . . [h]e also mentioned,  because they have some businesses in Russia, the lagged impacts in inflation are just now starting t manifest themselves.  So much of what we saw at year end with rising wages and supply chain issues, they’re actually just now starting to push through and will continue to push through over the course of the next few months.  If you look at the history of inflation, there’s a hysteresis effect, where there’s a big lagged effect of it, so . . . I think it’s going to be much harder to tame than we think and it’ll take much longer, and it’s gone be more more challenging for financial markets as a result, and if we stop short, like we did in the mid-70s, remember we had an inflation bulge in the 70, and another one just like now into ’73 and 74, the Fed hiked enough to put us into a recession in late ’74, then they stopped and we had a massive inflation bulge into the next decade . . . how serious are they about truly killing inflation?”

Ever wonder what happens if the Fed, who’s pivoted towards quantitative tightening (“QT”), and taking away the punch bowl suddenly becomes skittish if things sell off too quickly? Think about it (4 rate hikes of 50 bps each = 2% by September + $90B a month of QT). If the Fed drains the bathtub that quickly and rubber duckies/asset values fall biblically from the sky, how fast do they backtrack?

It’s one thing to talk about taming inflation, but when your actions cause Amazon stock, something almost everyone owns, to fall 28% since March 31 (i.e., in 36 days) . . . Houston we have a problem.

Wealth effects are real, behavioral finance is real, and if you crush asset prices, we can almost guarantee you’ll crush the economy when our economy is based on 2/3rds individual spend. We’ll get a triple-thunking of high inflation, a recession, and terrible consumer sentiment, one that’s feeling significantly and materially poorer.

So the path of least resistance is to back off. In all likelihood, politicians will force the “independent” Fed to retreat. Force is likely not the right word, but let’s call it that. We know though that much of the inflation we’re experiencing will likely worsen, or at least persist. It’s only just started . . . the hysteresis effect.

40% of the rise in the consumer price index (i.e., inflation) is caused by higher energy and food prices, and almost certainly, those two things will continue to climb because of shortages stemming from long-term structural underinvestment and/or the Ukraine/Russia war. Moreover, if wages begin to spiral as we shift our spending to labor-intensive services, it could add another tailwind to inflationary pressures.

So play it out. Fed backs off over the next few months right before mid-term elections. Republicans sweep Congress on the backs of an economic downdraft, an angry and dejected electorate, and a weak administration. They then re-run their Obama playbook of stifling the Democratic agenda, while the Fed for the next few years lose control of the narrative, their influence, and ability to control/quell inflation. Two years pass (i.e., the remaining 2 years of the Biden administration) and now we’re heading into the 2024 Presidential election. If inflation continues to persist, well, guess which party will finally get the “Volker” mandate to kill inflation? See what we mean? It’s That 70’s Show on rerun.

Undoubtedly the above is really just a stream-of-consciousness, run-on-sentences, cold-brew-coffee-fueled smorgasbord of thoughts. Yet, it’s plausible right? Not only that, it’s a PTJ derived plausibility, which is why it’s something to ponder. More importantly it’s something to really consider because if duckies and avocados are falling from the sky, reality is hitting the cold hard ground. Things are a-changing, and PTJ knows it, we know it, and the squirrel knows it.

He just caught on faster to PTJ’s thunking is all.

Brilliant bro . . . brilliant.

Have another avocado.

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