AM Brew, May 18th 2022

This morning as of Noon London time, risk assets are a bit exhausted after yesterdays strong snap-back rally. US Equity Futures are trading down between -30 bps and -60 bps, gold & silver down slightly, and the Euro, Pound & Yen trading off after yesterday's rally. Oil continues to be a monster, up 1% to $113.60 in morning action.

Our readers know we were positioning for yesterday's pop, and our readers know that we are also looking for confirmation beyond the initial move. One thing is for sure, avoid shorting oil until there is a geopolitical data point underpinning the thesis (i.e. massive OPEC increase, end of Russian aggression, US legislation etc.).

Powell's comments yesterday were taken well by the market, but our interpretation was not so bullish - our interpretation is that the Fed is saying "fighting inflation comes first, markets are not as important". At some point, the Fed would backstop hemorraging markets, but these levels are not close. It appears that it would take 6% mortgage rates and 3300 on the S&P to get the Fed retrace its hawkishness.

Sri Lanka is on the verge of defaulting on their debt. This is old news but its never good when countries actually default. Investors must be extra diligent to pay attention to "the obvious" to ensure (a) take advantage of any mispricings and (b) if you are on the wrong end of a mispricing, to adjust your portfolio accordingly. For example, look at the reversal of the risk premium on Chinese government bonds:

In the absence of a Taiwan invasion, this chart seems reasonable enough, but anyone buying a 10 year Chinese government bond should be discounting the possibility that if they invade Taiwan, payments of all types will be in serious jeapardy and your custodian could theoretically halt trading or deliveries. The point is that there are some obvious risks in the current market that must be properly priced - otherwise pay the price.

Volatility remains high, so it remains a traders market. Vol term structure is upward sloping to September:

Earnings season is mostly in the rear-view mirror, so the morning news is mostly political, with the big earnings news is Tencent's disappointing release. Tencent's revenue was 10 basis points higher: that is not a typo - Tencent's revenue was flat & profit was down 50%. This is significant because within the next 3 years, you will see similar results from FANG names, and in fact Facebook has already sent out its warning. Tech can't and won't grow 10% in an economy that grows 2%. Yes, tech will outpace economic growth as traditional models are disrupted and the world digitizes, but comparisons will become more and more difficult as tech grows. Eventually the growth will flatten and a lot of these tech names will be 5% growers. If you agree, position yourself accordingly.

Lots of geopolitical news out there today: Johnson & BOE inflation crisis, Sweden & Finland dealing with Turkey on NATO, Yellen's global tax plan, deadlocked Pennsylvania Senate race, Sri Lanka default, etc.

Target imploded 22% in the premarket, as their margin compression was much worse than WalMarts. Target noted "aggressive discounting in general merchandise". Feeling foolish for not having that trade on, as its obvious that Target was at risk of worse than WMT numbers.

The Fed's liquidity squeeze is starting to work. Used car prices have just started to roll over and lumber futures are down significantly off their peak:

Target & WalMart confirmed that people have been pulling back for a while now, and this is going to continue until inflation is under control. Belt tightening will hit most areas of the economy ranging from Netflix to restaurants and home prices. Positioning for snap-back rallies does not change the fact that we are in for some brutal second quarter earnings releases starting in July.