The Market Is Approaching A Tipping Point

Summary

• It's time to call a spade a spade.
• Markets are reaching a tipping point between the battle of the investment narratives, and they are ending.
• Value is going to outperform growth. Energy is going to outperform tech.
• Bubbles only last as long as there's enough money to keep inflating it. Once it stops (Fed tapering), and the moment it just stops growing, that's when it ends.
• Looking for a helping hand in the market? Members of HFI Research get exclusive ideas and guidance to navigate any climate. Learn More »

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Important note: This article was first published to HFI Research subscribers on September 13th, 2021. All charts in this article have been updated as of today's prices.

The battle of the investment narrative, that's the best way to describe 2021.

It's been a battle in:

• Inflation vs deflation
• Real economy (cyclical and commodities) vs new economy (tech)
• Value vs growth
• A fight for normality vs COVID

If you are in the investment business, the landscape in the past 9-months has been far from easy. If you are in the inflation camp, you looked spot-on for 2/3 of the year before the last 3-months threw a wrench into everything. And if you are in the deflation camp, the rising inflation expectation along with commodity prices are making the arguments weaker by the day.

Whatever your stance, 2021 is not easy because there's been no apparent victory in any of the narratives.

This year has not offered market participants in the way of a clear narrative. And similar to 2000 and 2008 when market narratives are conflicted, the market is approaching a critical tipping point. It's time to decide a winner and when this happens, markets tend to get volatile fast.

Friday's late sell-off was an early glimpse into what's going to happen to the broader market when the Fed starts tapering. It's evident now based on US economic data that tapering is going to happen and likely at the end of this year.

And as we've seen in this era of easy Fed monetary policy, what the Fed does has enormous implications on the rest of the market. So the logic is straightforward and simple, but the potential outcome is far from it.

Logically, all the things that have rallied enormously post Fed's easy monetary policy should start to fall. The lists include:

• High growth tech
• Bonds

And the things that should benefit from a tightening include:

• Commodities
• Cyclicals
• Value

One could argue that all things will fall in tandem, but the latter ones will fall less producing relative outperformance. That's hardly a brag worth mentioning (i.e., I performed better because I lost less money).

But during times of uncertainty, we turn to charts and historical market patterns for guidance. Charts tell the story of how past market participants reacted, so it doesn't give you a perfect guide into the future, but it sure beats the hell out of guessing.

One chart I keep pointing out is the growth vs value chart:

And if you look at the uncanniness of the chart in 2021 versus the one back in 2000, you will notice that following the Nasdaq bubble pop of March 2000, the Nasdaq actually roared back by September. But with the Fed raising interest rates at the time, the tech bubble burst, and everything came crashing down.

This time around, the Fed is simply slowing the pace at which it's pumping liquidity into the system (i.e., tapering). But as we've seen in bubbles, you have to run faster just to stay in the same place. So the mere fact that liquidity is slowing will signal less buying of speculative assets in the future, and thus, push prices lower.

To illustrate my point a bit better, here's a chart of Zoom (ZM), one of the biggest beneficiaries of COVID.

The valuations are self-explanatory for anyone that knows how to read a financial statement. But for those of you new to chart watching, doesn't this look similar to the chart below:

Yikes, am I right?

Again, history is a great friend in this case, and here's the chart of Nasdaq back in 1998-2001.

And here's a chart for another bubble beneficiary, ARKK:

They are all uncannily similar in that 1) there was a parabolic rise in share price, 2) the rise was not justified by fundamentals, and 3) they have failed to sustain any momentum to the upside for longer than 6-months.

In addition to the momentum stock charts that appear to be breaking, the Nasdaq versus Energy chart is also breaking lower (implying energy to materially outperform tech going forward).

We think this trend is set to accelerate in the coming days/weeks.

Earlier this week, one of our long-time subscribers noted that bubbles are those that didn't participate in them. We strongly disagree. Financial bubbles are when asset prices deviate far from the scope of reasoning. At the end of the day, an asset is worth the future cash flows it can generate. Anything that can't generate cash flow is considered speculation. To argue that a bubble is something those who are rational-minded did not participate in is like saying everyone outside the insane asylum is the crazy one.

So in the spirit of trying to figure which investment narrative is going to win the battle, we are leaning towards:

• Inflation
• Value
• Real economy
• Real assets
• Normality

The market has had to grasp the conflicting sides for a good while now, but we think the market is reaching a tipping point. It's time to call a spade a spade. Bubbles only last as long as there's enough money to keep inflating it. Once it stops (Fed tapering), and the moment it just stops growing, that's when it ends.

Analyst’s Disclosure: I/we have a beneficial short position in the shares of ARKK, ZM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.