Navigating Market Sentiment: Bank run, Recession & AI
The most recent barrage of economic data has been unveiled, prompting the market to grapple with the puzzle of the economy's resilience in the face of myriad challenges. Historically, any one of the events from the past years – the Evergrande crisis, COVID-19, Quantitative Tightening (QT), rampant inflation, the Russian-Ukrainian conflict, the cryptocurrency implosion, or the most recent bank run – could have plunged the market into a years-long slump. Indeed, the market continues to exhibit resilience, which we believe may be driven by a FOMO (Fear Of Missing Out) sentiment reminiscent of 2008.
While it's true that millionaires are made in recessions, we find ourselves questioning the validity of this paradigm in a world where this knowledge is now commonplace. In this article, we will delve into a series of interconnected events, aiming to discern a more comprehensive understanding of the market landscape and its behavior with a more informed perspective and potential future trajectories.
Recession
The current behavior of the market suggests that we may be standing at a critical juncture. There are a few potential directions from here: the market could defy expectations and continue its rally even amidst a recession; it could start to decline in response to deteriorating fundamentals; or, it could stagnate, remaining flat for an extended period, say, the next five years. This uncertainty begs the question: should we take a bullish stance, buoyed by the market's demonstrated resilience, or should we adopt a more cautious approach, allowing the market to recover from the apparent erosion of its underlying fundamentals?
The National Bureau of Economic Research (NBER), traditionally announces a recession retrospectively, often several months after its onset. The first two quarters of 2022 have already seen consecutive declines in GDP. However, NBER's established definition of a recession is not solely based on GDP. It encompasses a "significant decline in economic activity that is spread across the economy and that lasts more than a few months." This definition takes into account a multitude of factors including unemployment rates, industrial production, political pressure from the White House, among others.
Given these considerations, the question remains: how should we navigate these uncertain waters?
The issue of the debt ceiling, while often causing considerable hand-wringing, typically resolves itself in due course and is largely considered a non-event. Meanwhile, inflation appears to be inching towards a state of control, registering at 4.93%—slightly below the anticipated 5%.
The US Unemployment Rate stands at 3.40%, a marginal decrease from 3.50% the previous month and 3.60% the previous year. Additionally, average annual expenditures have seen a significant 9.1% increase to $66,928 in 2021, up by almost $5,000 from 2020 and $3,900 from 2019, marking a stark turnaround from the 2.7% decline witnessed from 2019 to 2020.
At face value, these indicators paint a picture of a robust economy. The Federal Reserve's gradual halt in its rate-raising spree appears to be inviting bullish investors to start building positions, anticipating future growth. While some may opt to "sell on the news", we could potentially see the market rally following a period of consolidation.
Nevertheless, despite these seemingly positive signs, there's an undercurrent of unease. The surface-level indicators feel somewhat contrived, almost as if they're masking a deeper issue. It's disconcerting that none of the previous crises have seen conclusive resolution or recovery. This disconnect raises questions about the underlying health of the economy and the sustainability of the current market trends.
SoftBank on Artificial Intelligence
A recent Wall Street Journal report focused on Masayoshi Son, the CEO of SoftBank, who boasts an impressive track record as one of the most successful investors and traders in the industry. At one point, he held the title of the world's richest man before the Dotcom bubble burst in 2001. His investment in Alibaba alone netted him an astonishing 250x return. However, Mr. Son has recently made a significant shift, reportedly liquidating almost his entire stake in Alibaba to pivot towards Artificial Intelligence (AI) investments. This strategic move offers valuable insight into market dynamics and provides critical data for shaping investment strategies.
Despite his earlier successes, Mr. Son's recent performance has been less than stellar over the previous years. SoftBank, recognized as one of the world's most influential tech investors, has been on the defensive during the time, curbing its spending drastically after numerous startup investments went awry during the recent tech downturn. However, it seems the firm is ready to shift its stance, with CFO Yoshimitsu Goto stating, "We are getting ready to go on the offensive with the AI revolution on the horizon." This is a significant move. SoftBank's recent losses, amounting to $7.2 billion and $12.6 billion a year earlier due to the Vision Fund, seem to contradict the notion of a methodical strategy. If we consider this from a psychological perspective, his decision to cash out of a successful venture to pursue another potential "win" might suggest an attempt to recoup his past losses leading him to engage in riskier and more emotionally charged strategies. Regardless of AI's promising future, the essence of the question is not whether AI is the future, but more about the timing of the investment.
Bankrun
The recent bank run on SVB is a pivotal event with ripples extending well beyond the financial sector. It could potentially influence our social fabric and exacerbate already unstable geopolitical tensions. It's plausible that this could serve as a catalyst for the collapse of additional banks, triggering further governmental rescue efforts that could strain an already inflation-burdened environment.
The bank run was precipitated by falling bond prices reacting to rising interest rates. Banks have an obligation to generate returns from customer deposits, and to do so responsibly, they often invest in safer assets like bonds or extend loans. SVB, with its riskier startup loan portfolio, fell victim to this pressure first, followed by smaller banks.
In retrospect, the onset of the bank run can actually be traced back to May 2022, with the cryptocurrency exchange, Terraform Labs. Prior to their coin, Luna, crashing, the company's founder, Do Kwon, stated most crypto projects would fail, and when they did, it would at least be "entertaining." His words are a display of perceived superiority, often precedes downfall - as indeed happened with Luna. This raises the question of why such behavior is exhibited despite the awareness of impending loss. Paradoxically, individuals at the peak of their success may engage in self-sabotage, as a subconscious mechanism to realign their state of being with a more familiar or comfortable level of success or failure. This event can lead to a cycle of boom and bust, with the individual constantly striving for success, attaining it, and then undermining their achievements, in a bid to regain a psychological equilibrium.
There is a high likelihood that traders who realized substantial profits during the period of the Fed's Quantitative Easing may find these gains gradually eroding. This could be due to taxation, capital losses, indulgent lifestyle expenses, or entrepreneurial ventures. There's a conjecture that those who have not experienced fear during this market downturn may find it challenging to adapt to the shifting market finding their strategies becoming increasingly misaligned with new market trends. Deep within our subconscious, we are confronted with a decision: Do we opt for short-term losses with the potential for future gains? Or do we choose present comfort at the risk of future struggle? As these decisions take shape, they will inevitably cast ripples across the market landscape.
In a more unconventional, yet plausible scenario, a significant bank run could even alter the investment landscape. Fund managers, traditionally focused on equities and bonds, might start exploring alternative assets like cryptocurrencies, commodities or real estate, as a means to hedge their portfolios against systemic banking sector risk. This shift could lead to an evolution in asset allocation strategies, possibly heralding a new era of investment philosophy where digital assets and decentralization play a more prominent role. Thus, the ripple effect of a bank run could extend far beyond the financial sector, triggering a sequence of events that could reshape economies, alter investment strategies, and even potentially spur on financial innovation.
Retail Investment Scene
Many who entered the financial arena during the Fed's QE and the Covid lockdown, which fueled a surge in retail trading and cryptocurrencies, have since sold their positions, having determined that the financial market is not their preferred playground. We believe this is a natural contraction. Once the market begins to find stability in the long side, retail investors will then slowly return.
Warren Buffett's considerable stake in Apple, representing nearly half of Berkshire Hathaway's total portfolio, is an interesting point of discussion. On the surface, it appears bullish, but a deeper examination from a trader's perspective suggests potential elements of over-reliance, complacency, and even a hint of fear. The market itself is significantly tethered to Apple's performance, prompting us to consider the necessity of a pullback. This event could be triggered by Buffett divesting a portion of his holdings away from AAPL. However, the catalyst for such a shift may necessitate a substantial event shaking the economic landscape - perhaps escalating tensions, either military or economic, between China and the US. Only then might the market find its footing and embark on the road to recovery.
In times of significant market volatility, uncertainty, and economic factors such as inflation and high interest rates, the psychology of traders often oscillates between extremes of fear and greed. This is further compounded when geopolitical tensions are added to the mix. Fear is predominant when inflation spikes or interest rates increase, as traders worry about the potential impact on corporate profits and economic growth. This can lead to sell-offs, as investors seek to minimize losses and protect their capital. On the other hand, periods of high interest rates might also be seen as opportunities by some traders who anticipate that these conditions may lead to more attractive valuations. Concurrently, geopolitical tensions add a layer of unpredictability, causing traders to second-guess their strategies and react more to short-term news events rather than long-term fundamentals. The resulting market turbulence often amplifies emotional decision-making, leading to higher market volatility. Understanding these psychological dynamics is crucial for navigating such challenging environments, as it reminds traders to stay grounded in their strategies and to avoid getting swept up in the prevailing market sentiment.
Projection
We correctly anticipated the 2022 tech crash, which lead to a rebound in Q1 as part of our 2023 rebound thesis. As we approach Q2, we foresee the possibility of increased market volatility and believe we may be at another crossroads. The market may soon struggle to find a clear direction. Nonetheless, based on recent sentiment, we believe there may still be some room for the market to run before it comes back down to find support and gain momentum for the next bull run.
The semiconductor sector looks extremely promising due to AI though investing in the sector carries substantial risk due to the geopolitical tension between China and Taiwan. Companies such as Nvidia, AMD, and TSMC stand at the forefront of this industry, with companies like C3.ai and Microsoft also worth keeping an eye on.
As a long-term strategy, we believe that Nvidia is one of the most compelling stocks to watch over the next three years. As AI matures and begins to surpass even major players like Google. However, the timing of entry into this space is absolutely critical. Entering too early can be just as detrimental as being wrong. At present, we believe that AI can be somewhat overbought. Practicing resilience during prosperous times and exhibiting courage during periods of adversity is the strategy we advocate. A pullback in AI is expected believing the China-Taiwan tension would eventually resolve peacefully.
We continue with our short term trading strategies to survey and understand stock behaviors keeping in line with the shifting market dynamics, which can pay off significantly when it comes the time to select the right stocks at the right time before the market begins to find direction for its next phase.
