High conviction is leading to big bets. To quote Mark Twain: “It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.” Excessive certainty is
your enemy in investing, as it is an incentive to take above average risk. Beginning May, we have seen a continuation of excessive risk-taking in Gold, Silver and Copper. Especially
speculative money had a high conviction that commodities will join the meteoric rise of AI stocks. Unfortunately, that expectation did not materialize, and buyers of the past 4 weeks are now sitting on considerable losses. While some of the big bets have been cut, there is still too much exposure, especially in the copper market, and those bets need to get washed out.
Physical tightness will emerge in the next 6 – 12 months but copper needs a new bottoming phase, which is usually accompanied by washouts. The big drop in the price of crude oil has
sharply reduced the crowd which believed in an escalation of the war in the middle east. Bullish bets on Brent have dropped to a multiyear low. While equity markets looked more
balanced by the end of April, the past month has seen a slow return of “more of the same” of what investors have witnessed since the beginning of the year. On a relative basis, all
sectors once again are losing ground against technology, and there is a clear danger that this behavior will accelerate into June. The demand for large cap technology companies stems not only from above average return expectations but also from the continuous bid from passive investors. To replicate the S&P500, it is sufficient to strongly overweight a few large cap companies. The synthetic trade is buying fewer and fewer stocks. Finally, the “narrow trade” is getting additional demand from retirement money, that is on the same autopilot as passive investors. George Soros stated in his theory of reflexivity that in situations that have thinking participants, the participants’ view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. That is the principle of reflexivity. Simply speaking, price can affect fundamentals and vice-versa. The concept of reflexivity has also been labeled as a self-fulfilling prophecy or the bandwagon effect. This can lead to extreme price trends in financial markets, where price completely decouples from reality, which in the end leads to market bubbles. Currently, we see early signs of such a behavior, where solid and relatively cheap companies are left behind. The autopilot system we currently witness poses an extreme danger for the US stock market. It seems to work well for now, but once the trend reverses it will become a source for extreme losses. From 1990 to 2000 the Nasdaq was looking at a tenfold performance. Since the beginning of the bull market in 2011, the Nasdaq once again is looking to do the same. There is still some juice left in the tank, but it is obvious that the market for technology companies is moving towards an end game. The current bifurcation in the stock market, where some few are doing extremely well while the biggest part remains left behind, could well be problematic for a central bank`s decision making. Contemplating the current US stock market would lead to the conclusion that the economy is doing extremely well, while in the end, the performance is driven only by a few.
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