That Was Then……it is 2024 Now!

The much-expected U.S. recession in 2023 refused to show up as it nursed the last remnants of the COVID-19 safety net/fiscal stimulus still percolating in the system. More important was the repair and realignment of the broken supply chains that kept a check on inflation. Oil could have been a spoiler with Russia sanctions in play but economic sanity short-circuited a supply shock. A regional banking crisis was swiftly brushed under the carpet by making FDIC guidelines irrelevant. Hikes in the Federal Funds rate or the Fed’s meaningless commentary did not matter as the real culprits lay elsewhere – in the amount of money supply – M2 ($20.767 trillion as of November 2023) and the Federal Reserve’s balance sheet ($7.713 trillion as of 12/27/23) that have barely budged from their peak levels in 2022.

Separately, Generative AI, the new shiny thing came just in time to keep every idiot’s FOMO fantasies alive, and over time, the expectation of a recessionary hard landing morphed into a soft landing but eventually turned out to be no landing at all. With the financial transmission mechanism still in a comatose, price discovery was and still is whatever the circus clowns from the Federal Reserve want them to be. Everything else is just a narrative that gives short shrift to inconvenient economic details. Meanwhile, broken economics, woke politics, social brainwashing, and zero-sum geopolitics have normalized insanity but on the highway to hell, self-righteous arrogance was the perfect ticket to success. That was 2023!

The question for 2024 is: How long can this Potemkin village facade that hides the debt-driven and debt-laden economic rot keep going, and how far can the make-believe narrative be stretched from reality before it blows up? At the end of 2023, U.S. public debt outstanding was at $34 trillion and tracking an exponential path with debt up $1 trillion in the past three months, up $2 trillion in the past six months, up $4 trillion in the past two years, and up $11 trillion in the past four years.

Take a moment to sip on that thought and dwell on the logic driving the estimates and assumptions on 1) GIGO Algorithm/ROI of AI, 2) Nature/Magnitude of Growth, 3) Cash flows/Valuations, 4) Inventories/Business Cycle, 5) Fed Balance Sheet/M2, 6) Interest Rates/Inflation, 7) U.S./China Vulnerabilities, 8) Geopolitics/Supply Chain Disruptions, 9) Engineered Economic/Social/Political Chaos, and 10) Globalist/Woke/Deep State Agenda and Lies.

Specific to our stock coverage, we believe all of them are currently over-hyped, and over-valued, with growth/inventory dynamics pointing to a tired business cycle, AI hype notwithstanding. As we enter 2024, we are adjusting our fair values given the lower interest rate dynamic driven by the Fed, and also discounting cash flows a year out further. Our price targets fall within the 3-year operating cash flow multiple ranges, and compared to year-end 2023 prices track 15% to 30% lower, averaging ~22% lower (See Details Here). The primary driver for our non-consensus view is we assume less growth, and also look for a valuation reset amidst a likely recession by mid-2024. At the same time, given the economic/market insanity that is widespread, we are open to the possibility (low probability) that our coverage stocks could also go bat-shit crazy before heading down for a sharp decline in 2024. We know what happened in 2000. Trade safely, and invest wisely.  

What Have We Done For You Lately?

As of 1/31/2024 HPstrats’ equal-weight performance for January 2024 and YTD 2024 stands at -0.3% versus +0.6% for QQQ Equal Weight (QQQE).

After our research coverage launch on October 1, 2023, with a bearish stance across our entire coverage universe, HPstrats’ equal-weight performance started on a solid note with HPstrats at +5.8% gain in October versus QQQE at -4.7%. However, that was sharply disrupted by the “November to Remember” which saw the biggest monthly easing in financial conditions in history (per GS Financial Conditions Index) and was soon followed in December by Federal Reserve guidance of three rate cuts for 2024, but the market priced in six rate cuts anyway. With such market-moving dynamics kicking in quick order, it was painful to see FOMO euphoria tossing logic out of the window with a vengeance. However, we are confident that we will fare better in 2024 as synthetic economic or market constructs are difficult to sustain when they are already overstretched and lack fundamental support.

The troubling part about the Fed’s messaging was it was more about interest rate manipulation than about subduing inflation given the troubling macroeconomic signs all around. If for some reason the Fed believes that it has conquered inflation despite the disconnect with reality, the Fed’s policy of prematurely declaring a victory on inflation in the 1970s offers an interesting analog, and this time inflation could come back on an express schedule to much higher levels (Chart credit below – Zerohedge).

Time will tell how things will shape up as the Fed dances naked at the crossroads of interest rates and inflation.

ANNOUNCEMENT: October 1, 2023: We have initiated research coverage of 25 companies in the Global Technology landscape focused on Semicap Equipment, Foundries, Semiconductors, and Consumer Technology (Apple, Microsoft, Alphabet, Amazon, Tesla, and Meta). See details here.

Welcome to our streaming thoughts……

Artificial Intelligence (AI) is Alluring Because Native Intelligence is Missing:

Let’s start with AI, AI, AI !! Barring the conversational interaction and experience with what is in effect an upgraded, gloried chatbox, much of the popular discussion is clueless nonsense. As a timely reminder, Hock Tan, CEO of Broadcom rightly pointed out to investors that “high-performance computing was the old term for AI, by the way. So that was it because it was very dedicated application workloads and not a scale-out as large language models drive today”. As high-performance computing (smart AI) scales up in complexity, scale-outs in terms of everyday applications (dumb AI, for lack of a better phrase) driven by LLMs will be ubiquitous. But the snake oil being sold from AI FOMO may not pan out as we believe that AI will be addition by subtraction – be it on budgets, spending, productivity, or people – if it is to make sense on ROI. We suspect, after the high level of spend on all flavors of AI in 2023/2024 across the economy, many “AI companies” will tread the same path as Pets.com and will die quietly, and buried unceremoniously. Even as the progression in productivity marches on with AI and with guardrails (hopefully), there is no disputing that AI for all of its potential is by design de-constructive, deflationary, and hence disruptive. We have our fingers crossed with the observation that just as smartphones do not make people any smarter nor will AI make people or businesses any more intelligent just because it is available and accessible. As AI seeps into mainstream usage, the popular refrain will then be: I have upped my game, now up yours! Cringeworthy LOL!!

S&P 500 earnings:

2023 S&P 500 earnings are expected to track ~$214, up 8.6% versus 2021. For 2024, earnings expectations are at ~$242, or a 13.4% increase (we are very skeptical!). Underneath this “growth/stability” since Covid-19 hit the world is the vast global stimulus supporting it: ~$6.6 trillion in U.S. stimulus and $4.7 trillion in Federal Reserve actions, and ~$22.0 trillion in global stimulus and central bank liquidity actions. A large portion of the monetary actions are still part of the financial landscape and explains the difficulty in gauging the underlying economic/business strength. S&P 500 ended 2023 at 4,769.83, up 24.2%, a mirror image of 2022 when the index declined by 19.4% to 3839.50 from 4766.18 in 2021 and lost $8.2 trillion in value. Similarly, the Nasdaq composite ended 2023 at 15,011.35, up 43.4%, and making up most of the losses seen in 2022 when the index declined by 33.1% to 10,466.48 from 15,644.97 in 2021. The global picture was no different with the MSCI World Index tracking global equity markets up 21.8% in 2023 making up for most of the 19.5% decline in 2022 that wiped off ~$25 trillion in equity value around the world. On the bond front, the Bloomberg Global Aggregate Bond Index was up 5.7% in total return largely due to a year-end surge compared to a 16.3% decline in 2022 that wiped off ~$9.6 trillion in value. More importantly, negative-yielding debt at $18.4 trillion, ~25% of all bonds at its peak in December 2020 finally vanished by January 2023. Despite U.S. stock market euphoria in 2023 tied to AI/technology and lowered inflation, the ride forward will likely be a lot bumpier when economic dislocations manifest as the stimulus effects fade away.

Federal Funds:

We previously expected Federal Funds to settle at a terminal rate of 6.0% to 6.25% by early 2024 compared to 5.25% to 5.50% currently – that is not likely now. As we enter 2024, market expectations are for six rate cuts after the Fed chair himself touted at least three rate cuts during his latest tripe on monetary policy in mid-December 2023. The question then is – are rates coming down because inflation concerns are largely done and the economic backdrop is stable OR that rates have to come down because we are most likely heading toward a recession? Federal Reserve’s job as an inflation firefighter is much tougher than the monetary arsonist role it played by pouring money supply (M2) ($20.767 trillion as of November 2023) gasoline in an economy whose growth rate in the last couple of decades averaged 2%. With a starting point at zero bound on interest rates as of March 2022, the reverberative effects of the policy shift on interest rates will likely come out in full force in 2024 as the cushioning effects of rapid money supply steadily fade into the background. For reference, the Federal Reserve’s balance sheet was at $7.713 trillion in assets as of December 27, 2023, down 14.0% from its peak at $8.966 trillion seen earlier on April 13, 2022. For perspective, we note the balance sheet was at $4.2 trillion in February 2020, just before COVID-19 went mainstream, and $870 billion in August 2007, before the financial crisis of 2007-2008. Fed’s targeted and preferred inflation rate at 2% is a fantasy, and we see inflation settling at 4% to 6% (down from 5% to 7% earlier) in the intermediate term as some of the key ingredients of inflation like the higher cost of capital, de-globalization, supply chain dislocations, ESG/Climate politics, labor/skills shortages are now structurally embedded despite the offsetting effects of technology in terms of higher productivity and lower costs. The broader issue that shifted our expectations favorably is while the U.S. macro situation is troubling, for most of the other major economic regions (Europe, China, Japan) it is far worse.

Central Banks

To make a long story short and simple, we view the Federal Reserve and by extension, other leading central banks ECB, PBoC, and BOJ playing the role of arsonists and then pretending to come to the rescue as a firefighter. Their mandates are by design very interventionist, prone to injecting instability, and dangerously powerful given their activist roles in determining the money supply and the cost of money. In a connected world, while the transmissive effects are global, the second-order effects are local because of the asymmetric access to capital, unpredictability in the flow of capital, and the magnitude of misallocation of capital. In reality, entrenched businesses with scale and technology advantage the world over used the flow of cheap and plentiful capital to methodically strip mine the economic architecture and societal cohesiveness and repackaged their financial engineering as “innovation” with a winner-take-all approach. In such an environment, business model viability did not matter as long as access to capital and technology’s enabling role was used to pillage and destroy existing businesses and gain scale at the expense of profits. In their efforts to stabilize the system, the central banks seem to be blind to the ripple effect of their actions all the time. After all, the path to hell is laid with good intentions, and the activist global central banks are no different.

Geopolitics and Geoeconomics:

A connected world – digital or otherwise, a magnified communications impact, and a compressed timeframe accelerated by technology – is a world ripe for change. A change where all power is diffused but gets amplified with connectivity, where old hierarchical power structures are kept in check by situational awareness, where the free global movement of capital and labor challenges the foundational assumptions of societal cohesion, where technology has removed the frictional costs as a barrier to entry and exit, and a change where common sense and logic are replaced with emotions and feelings. Here are our quick observations of a clumsily connected world on planet Earth.

• The U.S. is a sad question mark as to what it has become on many fronts. Will it course correct itself in time?
• China believes it can humiliate and piss everyone off on its way to a global power status but it will be checkmated.
• India will be misjudged and insulted but it will humble the world with its message and actions that resonate well.
• Africa, the Middle East, Latin America, and Central Asia will be growth spotlights with mainstream global integration.
• Europe will self-destruct its way to irrelevance politically, economically, and socially with idiotic/delusional policies.
• Russia is a pain as it is/feels misunderstood and undermined. Count on it to be the anti-hero on the global stage.

Living in Strange Times……

We have been living in strange times for nearly two decades where being delusional is the agreed upon and reinforced consensus where monetary policy has become a farce, fiscal policy has been reduced to a debit card with no limit on spending, and investors have become habitual gamblers whose vanity has checkmated any remaining sanity. Financial markets have for long become deceiving, disconnected, and disengaged from reality and have become akin to a rigged casino. In terms of impact on society, we always noted that once you cheapen money, money will come back to cheapen you. Given how financialized in the extreme every economic activity has become we are in the midst of multiple Minsky moments (the phase of a financial cycle where many financial assets suffer from liquidity and solvency problems) all papered over with more money and pointless policies. With all the core elements of vibrant capitalism – price discovery, capital formation, risk mitigation, liquidity, and velocity – dismissed outright, we expect political, social, fiscal, and monetary policies to stumble from one mistake to another as wealth creation mechanisms have become perverted and subverted. Adding insult to injury, a whole generation of psychopaths are in seats of power, wealth, and influence amidst a global reordering of aspirations, power, productivity, and wealth creation.

Red Pill vs. Blue Pill and the gutting of economic, social, political & cultural structures

In the movie The Matrix, the main character is offered the choice between a red pill and a blue pill – “You take the blue pill……the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill……you stay in Wonderland”. The red pill represents an uncertain future but frees one from the enslaving control of the Matrix’s machine-generated dream world that the blue pill offers. From the lens of Matrix, we see a world where: A nihilistic deconstruction by illiterate idiots of cultural norms and the social contract (CRT, sex/gender, pronouns) is now very fashionable. Irresponsible politics and a power grab by the networked rich/powerful, media/social/academic elite, and un-elected, unaccountable bureaucrats and technocrats have come to dictate policy and capture institutional frameworks. Virtue signaling (DEI, ESG, Net Zero) and tyranny (censorship) are now used for social influence and social compliance/control, respectively, and free speech is seen as a threat, with no room for fact-based debate or even a difference of opinion. An Us versus Them mindset is compounded by the societal comatose on rights, responsibilities, and accountability. There are no innocents here as it is not the intent but the character, content, and evidence of action that matters – one doesn’t have to look far or dig deep to see that it is a mix of George Orwell’s 1984, Hayek’s Road to Serfdom, and the science fiction movies The Matrix already playing out in real-time.