Not Every Default Is a Lehman Event- Cognitive Bias Was on Full Display This Week

Maslow’s hammer –> careful of cognitive bias
Equity markets around the world were roiled by news of the Evergrande impending debt default. And coupled with concerns ahead of the Sept FOMC + potential US govt shutdown + potential debt ceiling, and this made for a deep descent in stocks on the first two days of this week.

– Fortunately, stocks found their footing and have rallied HARD in the past two days.

Investors panicked mainly because so many pundits were quick to label the Evergrande episode another “Lehman event” and this reminded me of Maslow’s hammer. If you are not familiar with the “law of the instrument,” the Wikipedia abstract is below:

– in short, people who carry hammers look for nails

…this was not a good week to use the “Lehman hammer”
And this week, those carrying “Lehman hammers” found their nails. As humorous tweet below highlights, this was not a good week to use the “Lehman hammer” — lol.

ANECDOTE OBSERVATION: Perspective on week’s ping pong action
A fair question to ask is why markets seem to ping pong more violently in the past 18 months, compared to even the volatile periods from 2017-2019. And I can only offer some anecdotal observations:

“ping”
– large increase in retail investors, trading on headlines
– rising options trading volume –> higher embedded leverage
– still PTSD of institutions living in a post-GFC world
– rising preference for institutional investors to have “24 hour liquidity” — trigger happy

“pong”
– substantial cash on sidlelines –> dry powder
– growing US investor wealth now $144 trillion –> more capital
– shift away from bonds –> buy the dip
– investor confidence in stocks improving –> buy the dip So, this is just my anecdotal view on why equity markets have been ping pong like lately.

US Household wealth tops $142 trillion… staggering
The latest Federal Reserve Flow of Funds report (2Q2021) show US household wealth reached a staggering $142 trillion. This figure rose $3.5 trillion in 2Q2021 and now surpasses 600% of GDP.

– this is a stupendous figure
– should it surprise anyone that stocks have a bid?

– total US stock market cap is $46 trillion (Wilshire 5000)
– there is still ~$100 trillion of US household wealth that can be “allocated” to equities

US wealth is not as concentrated as might appear — top 20 richest Americans represent 1.2% total wealth
When reading media reports of the concentration of wealth in America, it sometimes paints the picture of US controlled by the modern-day “robber barrons” with 5 families controlling US wealth. But that is not entirely accurate:

– top 20 wealthiest Americans are shown below
– total wealth of top 20 is $1.8 trillion

– total US household wealth is $142 trillion
– top 20 are 1.2% of that total

Sure, the top 20 are ridiculously wealthy. The #20 guy is Len Blavatnik and he is worth $42 billion.

– but with $142 trillion of wealth, and top 20 people are 1.2%

– this means America has a lot of wealth, flat out
– and there are just a lot of mega-rich people

…Millennials inheriting $76 trillion over next 20 years –> in the larger timeframe, one needs to be bullish
The conclusion? This is a deep pool of wealth and this wealth is supporting financial assets today. The larger story regarding this wealth, is the generational impact it will have. We have written about Millennial inheritance in past reports, and I don’t want to tie up this commentary with those detailed charts.

– annually, our data science team estimates $2 trillion of Baby boomer wealth is inherited by Millennials annually
– Millennials have a higher risk preference for equities and digital assets
– Baby boomers would have a smaller relative allocation, hence, this is a structural increase
– Total inheritance over next 20 years will exceed $76 trillion

Can one be structurally bearish on stocks if this is the case?

Overall USA COVID-19 trends continue to show improvement…
As it’s now been well over 2 weeks since Labor Day, the holiday distortion should be fully cleared out. Both the daily cases and rolling 7D delta trends continue to show consistent improvement.

– daily cases came in at 119,009 for Thursday
– cases are now accelerating towards the downside

– 7D delta is -22,487 compared to -16,605 on Tuesday
– as the lower chart shows, there’s a huge downwards acceleration

The consistency of the trends suggests that the Delta surge is on the decline, especially as more individual states are showing case roll overs. More states will soon roll over, and the overall trends will continue to roll over even harder.

COVID-19 is still rolling over in many states, which is good
Below is the updated state case trends (7D moving average) and we show 2021 and 2020, just to provide some seasonal perspective. As you can see, cases are still decisively rolling over in 21 states.

– there was some distortions stemming from holidays but they are passing now
– SC, GA, WA, and OR are some examples
– we shaded in the distortions in red
– we believe these are distortions, then this is a sudden spike and collapse?

But we are emerging from these distortions, and the trends are generally improving nicely.  The key question is whether there will be a winter flu-related spike.

STRATEGY: Risk-on signals emerging in last few days + DeMark + other technicals strengthening
Earlier this week, during the initial downdraft in stocks, there was a risk of contagion and also a breakdown in investor confidence. And the technicals of the market were damaged as the S&P 500 fell below its 50D and even breached the 100D moving average.

– but in the past two days, these have rapidly repaired
– VIX + US 10-yr + Market liquidity have all moved to solid improvements – collectively, these are powerful risk-on signals

Positive “Price Flip” in the DeMark Daily for S&P 500
DeMark indicators flipped positive as well. The combo count experienced a positive price flip. You can see this below:

– As of Wed close, the DeMark daily count was negative (buy countdown)
– But the strong move Thursday negated that negative count to a positive

– This is a price flip

The DeMark Analytics team explains this below. A price flip takes place then the close is > 4 days ago. This interrupts the negative countdown. Thus, the DeMark signal has become essentially a buy signal (aka “sell countdown”).

– this is good

…S&P 500 closed above the 50D, after falling to 100D = good
Another solid technical improvement is the S&P 500 re-attained its 50D moving average. This is after falling below the 100D. This is a solid recovery. Take a look below and you can see how this mirrors the Oct 2020 move.

– stocks rallied big from there
– move evidence that we rally HARD from here

That is our view and we end the month positive as well.

Epicenter stocks waging a battleground here –> we see positive probabilities
Epicenter stocks have suffered in the past few months due to multiple factors, but it essentially comes to market wariness of economic vitality:

– Delta variant hitting visible economic growth
– Inflation concerns = Fed hawkish
– Interest rate falling = fear of double-dip or slowdown

It was a trifecta of headwinds. As shown below, the Cyclicals are just fighting to re-attain the 200D (relative to S&P 500). This is a positive development, in our view.

Interest rates above 1.4% = big news = Value not reflecting this yet
Interest rates have moved back above 1.4% and as you can see, affirming a solid uptrend in rates.

– curiously, Value stocks have not yet turned upwards
– we think this is a delayed response due to concerns about economic vitality (see above)

…RenMac chart underscores need to tilt to Epicenter
RenMac put together a great chart showing sector sensitivity to rising rates. As you can see below, the groups positively correlated to higher rates are all Epicenter sectors.

– message?
– tilt to Epicenter!!
– ESPECIALLY ENERGY

Now, I know Energy has been awful. But oil is back above $73. There is a sizable gap between oil and Energy stocks. So don’t give up plz!

Figure: Way forward ➜ What changes after COVID-19
Per FSInsight

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
**Performance is calculated since strategy introduction, 1/10/2019