The Five Stages of Economic Grief in 2023

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Here’s what Tracy’s watching

Many years ago, I talked about a big change that had overtaken markets. Put simply, the idea was that in an era of sluggish economic growth it made sense for investors to try to chase juicier returns by following the money as opposed to finding true value. This tendency ended up having a big impact on the way markets functioned.

Put simply, markets to be self-limiting. Prices of securities would rise to a point where their valuations would become unattractive, at which time investors would trim some of their positions, causing prices to go down. In practice, this meant that prices were usually policed by fundamentals.

In the mid-2000s, however, that dynamic seemed to dissipate. As Citigroup strategist Matt King put it back in 2015, investors began chasing inflows as a means of generating higher returns. Valuations were no longer limited by old-fashioned notions like the ‘fundamentals’ that professional investors to concern themselves with. Instead, it was all about running with the herd and hoping you could get out in time if something went wrong. ‘Flows before pros’ became the dominant theme.

Flows before pros reached its purest expression during the Gamestop/WallStreetBets phenomenon, but you could also trace its origins to the world of cryptocurrencies — where betting on tokens became an accepted activity. In that world, prices don’t matter very much either because there are (as yet) few fundamentals to speak of. As I wrote in December, the result of all this is something different than traditional investment or even speculation because it involves people betting on a single outcome. Either prices go up (‘I win’) or prices go down (‘I lose’).

Anyway, I was reminded of the whole ‘flows before pros’ dynamic after recording an upcoming episode with Nomura strategist Charlie McElligott.

We talked about the rise in zero- and one-day options (0DTE and 1DTE), which give both big and small investors the ability to bet on whether the S&P 500 will go up or down in a single day. These controversial options have exploded in popularity in recent months, and there is now a heated debate about whether these short-term bets are contributing to market volatility. 

But as much as these options represent the ongoing ‘tokenization’ of the market, where investors are betting on binary outcomes as opposed to price levels, there is some rationality behind them. Just like ‘flows before pros’ in the mid-2000s, there is a traders are using these.

As Charlie points out in the episode, investors are currently caught between two competing narratives — one where inflation runs hot and the Federal Reserve has to keep on hiking and one where deflation and even recession materialize. With no obvious dominant narrative, and with the possibility that a single jobs or CPI number can lead to big intraday swings, it makes some sense for investors to bet on single-day outcomes.

As Charlie puts, every day is basically it’s own trading ecosystem now.

And from that perspective, you can see why betting on short-term stock moves is so attractive right now. 

The episode with Charlie McElligott will be out next week, and we’ll also have Matt King on later this month.

Here’s what Joe’s watching

We’re not even done with Q1 2023, and I think you can count five distinct narrative shifts that have already taken place this year. In my career, I’ve never seen anything resembling this kind of whiplash.

Here are the five stages as I see it:

First two weeks of January: Recession watch. Lots of pessimism that the landing is coming and that it will probably be a hard landing. All the news heading into Davos was about how dour all the CEOs were felling.

Davos and its aftermath: Suddenly things started looking brighter. We got a decent inflation report for December, and even names like Larry Summers were making noises that the possibility of a soft landing had to be taken seriously.

February overheating: The soft landing vibes didn’t last long. People started noticing that used car prices were gathering steam again. Oh, and the homebuilders! The one area of the economy that was surely in trouble thanks to all the rate hikes was showing signs of life again. Like that GIF of The Undertaker popping up in a professional wrestling match. And so you got this nice stock-market surge, because the Fed was still on “recession watch” even as the data was looking encouraging again.

The Fed catches up: Over the first six or seven days of March, the Fed speak caught up to the new reality. Maybe 25-bp moves wouldn’t be enough. Maybe the glide path down to the 2% target would be much bumpier than thought just a few weeks earlier. This is the danger in declaring victory too soon. We’ve seen this movie before! This is why vigilance is so key.

Bank panic: Basically as soon as Jay Powell got done speaking on The Hill this week, we started getting anxiety about some regional banks, and their exposure to some of the weakest areas of the economy. First it was Silvergate, which had basically bet the farm on crypto. Then it was Silicon Valley Bank. Their troubles are right there in the name: Silicon Valley. OK ,it’s a bit more than that, but that’s kind of the story. Silicon Valley is in a slump, so the bank that banks it is going ot be in a slump.

And now the upshot, just after Powell hinted about doing more, the market is betting that he’ll be doing less. Yields on 12-month government notes were as high as 5.2% at one point this week. Now they’re back to 4.91% as financial market anxiety takes cuts off the table. 

On the podcast this week

This week we spoke with Brian Armstrong, the CEO and co-founder of Coinbase, the biggest crypto exchange in the US, about all the big problems facing the space right now — everything from massive price declines to more intense regulatory scrutiny. You can listen to that episode hereread the transcript over here

We also spoke with Corbu strategist Samuel Rines about his research, examining how companies have been taking price over volume in recent years. It’s a must-listen conversation, and also dovetails with some recent work from Odd Lots guest Isabella Weber. You can isten to the episode hereread the transcript, or our write-up of the phenomenon — which we called ‘excuseflation’ — over here

We also asked Rines for some reading recommendations. Here’s what he suggested:

• War by Other Means” by Blackwill and Harris is one I have reread a couple of times since the invasion of Ukraine. Does a great job of laying out the “geoeconomic” side of warfare, and is useful in framing the current conflict from a non-kinetic perspective.
• Alpha Trader” by Brent Donnelly is one to keep nearby at all times. Full disclosure, Brent is a dear friend. But it is a great book for reminding everyone (economists, strategists and traders alike) that nimble thinking and humility are necessary to being successful for more than a couple weeks.
• Complexity and the Economy” by W. Brian Arthur emphasizes the need to continually adjust / revise / test one’s presuppositions concerning the economic system and how it works. Useful reading following a pandemic that “broke” many models of traditional economics.
• The Storyteller” by David Grohl is both highly nostalgic (having grown up in the time of Nirvana and Foo Fighters) and oddly useful for markets. A combination of learning to tell a story, be persistent, and constantly evolve as a person (from -- say – a guy who didn’t/doesn’t read music to the drummer with Nirvana to the front man of Foo Fighters).

What we’re reading

- Dan Wang’s annual letter

- The dollar’s imperial circle

trucking company with 200 employees shuts down. 

- Why deposit taking and lending go together so well