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Good morning. It’s going to be a fun week. Rates will continue to move, as the market digests the jobs report and prepares for the CPI inflation numbers on Thursday. Consumer sentiment lands Friday, too. Yum China, Lyft, Uber, and Zillow are among the spicier companies reporting earnings. We’re looking forward to all of it. Email us: firstname.lastname@example.org and email@example.com.
The economic numbers are not scripture, but a prayer or two wouldn’t hurt right about now
Everyone was surprised by the jobs report on Friday. The most important part of the report, though, was not the fact that the economy added 467,000 jobs in January, three times the consensus expectation — even though that figure delivered an instant jolt to bond yields.
The amazing thing, as has been widely noted, was the revisions to previous months’ numbers, which made one whole narrative about the pandemic economy fall apart. The new jobs numbers for August, September, November and December were all revised upwards by hundreds of thousands of jobs; at the same time, the numbers for earlier months were revised down. Here’s a graphic from the FT’s news story:
Netting all this out, the sum of new jobs added in 2021 was only revised up by about 200,000, but the pattern of job gains looks much smoother now. What’s more, the government has updated its estimates of the size of the population and the labour force. From the BLS release:
The adjustments increased the estimated size of the civilian noninstitutional population in December by 973,000, the civilian labour force by 1,530,000, employment by 1,471,000, and unemployment by 59,000. The number of persons not in the labour force decreased by 557,000. Although the total unemployment rate was unaffected, the employment-population ratio and labour force participation rate were each increased by 0.3 percentage point.
The sudden slowdown in job creation at the end of last year never happened, and the labour force is significantly closer to returning to its pre-pandemic level than we thought. The whole story about pandemic-exhausted Americans saying the hell with the job market just saw its key premises kicked out from under it. As Andrew Hunter of Capital Economics summed up neatly: “All that time wasted discussing whether workers would return when, in reality, it was mostly just a statistical illusion.”
The revisions also change our view of where jobs have been slow to come back, as Matt Klein pointed out over at his indispensable Overshoot. The losses are less widely spread than we thought. Klein writes: “As of January, almost all of the aggregate shortfall in payroll employment is now concentrated in just three sectors: leisure and hospitality, membership associations and organisations, and public and private education.” (Membership associations are religious, charitable, labour and business associations, and no, we don’t know why they are having a bad pandemic). Here is his chart of the effect of the revisions:
The overall picture that emerges post-revisions is a stronger, steadier recovery, with the problems concentrated in specific areas, rather than an economy-wide malaise.
What lessons can we take away? The government data market participants obsess over day to day is not scripture. These are indicators, not hard, fixed facts. Revise your views based on a data release, but don’t overreact, especially when the indicators are not unanimous (this is all the more true because we all suffer from recency bias).
This is especially true lately, as the FT’s Colby Smith and Christine Zhang pointed out in December, because it’s hard to collect data during a pandemic. Here is a striking chart of the number of companies which have agreed to respond to the key employment survey:
Second, this is all another reminder that we are in genuinely new territory, where we will struggle to take our bearings. In markets, it always feels like things are more uncertain than ever before, but there is a plausible argument that we are currently in an objectively more uncertain moment. We should be less confident than usual in our judgments right now.
The recovery looks a bit stronger, and much steadier, than we thought. But we need to keep our fingers firmly crossed.
Death or glory: the FT stock picking contest
The point of stock picking contests is not to maximise expected returns. It is to maximise expected glory, while minimising expected humiliation. That is to say, all that matters is coming in first, not coming in last, and looking clever doing it. This ain’t investing, in other words. It is investing’s show-offy, egomaniac cousin.
The humiliation part is important, because it eliminates the wisdom of taking on a super high-beta portfolio, and simply hoping the market goes your way. You have to take big shots, but you have to hedge just a little too.
This is relevant because we just entered the FT’s stock picking contest, at the last possible minute, last night. The rules are simple: pick five stocks, each from a major exchange, and long them or short them. No funds or indices. Currencies moves don’t matter. Winner is determined by price return. Dividends only count in the case of a tie.
In constructing our portfolio, we started from the top, with this question: what is a macroeconomic scenario that is possible, but unlikely to attract other contestants? We reckon a lot of people will be betting on continued high growth and inflation. Indeed, that scenario seems pretty likely to us, too. So likely, in fact, that it is probably priced in already.
So we went the other way: for purposes of our portfolio, we are betting that as we exit 2022, global growth and inflation is positive but very low, and the credit cycle is normalising — that is, credit spreads keep rising toward historically normal levels. The Fed, under this scenario, will not do all five interest rate increases the market now expects, and will not start selling its portfolio of Treasuries, instead letting the balance sheet run off slowly. Call this the “new new normal” thesis.
Banks, cyclicals, and energy stocks are going to do poorly under those circumstances, and we have expressed that view with short positions on companies that are particularly sensitive to rates or economic conditions, or which have prospered for idiosyncratic pandemic-related reasons, but are not high-growth tech stocks. Here they are:
Comerica is probably the most rate-sensitive bank in America, as the chart below shows. It is all floating rate business loans on one side of the balance sheet and non-interest bearing commercial deposits on the other. Falling rates, especially with normalising credit spreads, would hurt it badly.
Cenovus is a Canadian oil producer that is churning out cash right now because of high oil prices. The regulatory winds are blowing against it, though, and a synchronised global slowdown would cut its stock in half — back to pre-pandemic levels, in other words. Everyone thinks that energy supply is tight and will stay that way, even if demand slows. We are happy to take the other side of that consensus bet, in the case of a synchronised global slowdown.
Infineon shares have had a great pandemic run, but they look expensive, and if the economy slows even as production bottlenecks abate, the current chip shortage could flip into a glut.
Needless to say, in a proper stock market correction, Comerica, Cenovus and Infineon would fare much worse than the average stock. Their betas (sensitivity to market moves) are 1.4, 1.9, and 1.3, respectively.
Next up, two more shorts, but not cyclicals this time. Rather, two companies that have procured extraordinary gains during the crisis for reasons we think are idiosyncratic and might go away. News Corp (beta 1.5) has had a very strong run in the pandemic — it is well above its pre-pandemic high. But even as we head into an election cycle, we think the Trump/pandemic news boom could fizzle, particularly under the kind of “new new normal” scenario we are betting on. And while we admire (and subscribe to) both the Wall Street Journal and Barron’s, we think the company lacks the New York Times’ hedge of also being a high-end lifestyle brand.
Of course, if the newspaper business gets badly hurt, Ethan and I are in trouble, too. But at least we will look prescient while we pack up our desks.
Lastly, GameStop. The short case here is the same as it ever was: a debt-ridden business in a structurally declining industry whose stock exploded overnight mostly on speculation. Now, we have no desire to become the next Melvin Capital, but unlike a real investor, we pay no carry and can’t get squeezed or margin-called. All that matters is the price a year from today. We credit management for using the meme stock boom to tidy up its balance sheet, but $100 a share is still preposterously expensive for this business, especially as financial conditions tighten.
Five shorts is no hedged portfolio. If the economy booms and inflation stays high, we are going to lose, badly. Perhaps not catastrophically, though. We think all of these stocks already have a lot of upside baked in. Admittedly, because we have no longs, we will need a down market to win outright, and down markets are much rarer than up markets. But we think we can do fine in a market that moves broadly sideways, so long as the rates and growth cool.
In short: we think this portfolio gives us a shot to win without risking last place, and because it is vividly contrarian, it might just make us look much smarter than we really are.
One good read
Should employers fret about hybrid work eroding a firm’s social bonds? Perhaps so, writes the FT’s Emma Jacobs, while leaving open the possibility hybrid might still be good for employees.
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