Santa Claus Is Coming to Town (With a Mask)
2020 is about to end. And it has been a year that we will never forget.
Whoever you are, whatever your job or personal situation, this pandemic is very likely to have impacted your life. Fortunately, the dramatic sanitary situation may improve in 2021, as there have been many positive reviews on Pfizer and BioNTech’s clinical study results.
In 2020, nature gave us a lesson of humility. The global economic system almost collapsed because of a submicroscopic infectious agent. And as already said before, the lives of billions of individuals have been changed because of the virus.
Many humans live in comfort (not all of them), and most have access to amazing technologies, but nature is always stronger than what we think. Indeed, risk is like energy, it cannot be erased, it can only be transferred.
How did we respond to that crisis? By printing and spending billions of dollars. Not to solve the health care crisis. Not to save small economic agents. Not to work on future challenges like climate. But to save the stock market.
That’s the main lesson of the Covid-19 crisis. What matters the most for the US and other Western countries is wealth. Because that is who we are.
Despite catastrophic economic consequences, this pandemic has fueled one the craziest speculative bubble the world has ever seen. Many people are responsible for that, but clearly authorities have played a key role, encouraging extreme risk-taking behavior while asset prices were already at historically high relative levels.
The last FOMC will make history as Jerome Powell said: “If you look at P/Es they’re historically high, but in a world where the risk-free rate is going to be low for a sustained period, the equity premium, which is really the reward you get for taking equity risk, would be what you’d look at.”
So, nothing to worry about?
You Only Live Once
The Fed has just officially endorsed the mania. Of course, the low rates argument is a fallacy (see Dear TINA, We Need to Talk), and America is playing a stupid game that will have disastrous consequences for millions of people (or more). Bad capital allocation is rewarded, and “greed is good” again.
As Charlie Munger recently said, “it is the most dramatic thing that’s almost ever happened in the entire world history of finance.” And he is right. This is one the biggest bubbles the world has ever seen. Probably as big as the South Sea Company mania.
I have been wrong on the fact that technicals could break this crazy market. The log-periodicity power law singularity (LPPLS) model did help me to detect some key ruptures on the Nasdaq, like the September sell-off, or ruptures on individual stocks like Peloton, Trade Desk, Palantir, and others. But I could not imagine that the market would be able to recapture the speculative dynamic after that.
It has, and speculation has got even bigger. Authorities are to blame for that, as the Fed keep on delivering even more dovish indications each time they speak. Whenever US equity indices go red, they quickly come to the rescue to force a short squeeze. That makes no sense on the long run, but at least people feel that you can never lose at this game. It’s even better than a casino.
Fair enough. But how is that supposed to end?
Contrary to numerous past bubbles, participants have not been discouraged by endogenous ruptures that occurred between September and December. Therefore, maybe an external trigger will burst this massive bubble. A black swan event is always possible, but it is already possible to think about two situations that could threaten the system.
First, the US-China tech war. The PRC already said that the tensions are structural and likely to stay even if Donald Trump leaves the White House. And they are right, since the Biden administration is not willing to remove tariffs. Thus, one should remember that Chinese authorities have already warned of a future blacklist of American firms, including tech giants like Apple.
Meanwhile, China has begun to reduce its exposure to US treasuries, probably to increase external pressures on the dollar. And that brings me to my second point.
There is one big trade on the market: long tech, YOLO, bitcoin, and short dollar. Infinite QE and record stimulus packages have created massive selling forces on the dollar. While most participants have accumulated net-short positions, the trend is likely to continue as long as stocks rally.
Said differently, it the stock market rises to the moon, then the dollar goes to zero.
People always say that central banks can ease forever. In theory, they can. But what happens if the dollar index breaks critical levels?
Below a certain point (Peter Schiff suggested 70), the Fed would have to choose between two terrible options: let the American currency collapse, or become less dovish in order to stop the bleeding. As hyperinflation may not an option from a political perspective, I believe that they will have to suddenly undo what they have done since the beginning of the 2000’s.
And of course, no one is prepared for such an event that would automatically trap bulls and destroy the craziest bubble of our lifetime.
Power Laws Do Matter, Even in 2021
As most bears have capitulated, I see many professionals recommending to “ride the bubble”. But there is no free lunch in economics. So, if everyone wins, it means that everyone will lose when the music stops. And there will be no additional warning. Never bet against nature.
All that being said, I want to thank all the readers of this blog. I launched it a few months ago, and I have received many encouraging comments since the beginning. So, thank you everyone.
I wish you a happy and safe Christmas, and a happy new year.
I expect 2021 to be another challenging year for the markets and for the economy, but at least people may be able to do things without taking to the risk to contaminate people they care about. And that’s what matter the most in my opinion.