Every few years, the stock market seems to be swamped by a “100-year storm.” Investors put their hands up and say “no one could have ever predicted this,” despite there being obvious clues that some sort of an event was imminent. Remember back to the 2000 internet crash when it was obvious that the tech bubble would eventually deflate. The surprise wasn’t that the bubble burst, the surprise was how closely tied consumer spending was to stock market profits. Or think back to the crash of 2008; did anyone in 2007 really question if a whole lot of subprime mortgages were going to blow up? I remember going to conferences and this was all people talked about. The surprise wasn’t that banks had to take reserves, it was that bad mortgages infected supposedly AAA securities, freezing up the financial system and forcing companies into margin calls. Even COVID wasn’t much of a surprise. We were all stockpiling toilet paper as the Chinese government rounded up old ladies and put them into detainment centers. The surprise wasn’t that COVID eventually escaped China, it was that governments panicked and shut down the global economy over a bad cold.
Each mega-crisis seems oddly predictable in retrospect—there was a problem that somehow escalated beyond what was expected. Even at the time, people recognized the problem, but they all hoped it was “contained.” This is because preemptively adjusting your portfolio is dangerous to your career if you’re under-invested during a market rally. Besides, you don’t want to be that guy who called ten of the last two crashes. As a result, portfolio managers often wade into scary events with full positions and pretend there was no way that they could have predicted the obvious.
I prefer to do things a bit differently as I’m playing with my own money. If something scary is on the horizon, I de-gross. Sure, I miss out on some gains when nothing materializes, but I’ve also side-stepped a few whoppers. Besides, I don’t mind missing some upside as there’s always another interesting opportunity once the proximate event has passed.
I bring this all up as a crisis is rapidly brewing here in the US. President Trump clearly won re-election, only to have it snatched through blatant fraud. You can agree with that statement or you can disagree. Honestly, I don’t care what your opinion is—this article isn’t about voter fraud anyway. We’re past the point where facts matter—this is about emotions and game theory now. President Trump thinks he won and about 70 million of his supporters feel like they just had something stolen from them. They’re pissed and see every data-point as proof of a system that’s been rigged against them. My question is; what happens next?
To start with, Trump could gracefully concede. However, we all know that won’t happen. Trump isn’t graceful (ever) and I’ve never once seen him concede anything. For much of my childhood, he was bankrupt and it never slowed him down—if anything, having his back against the wall made him stronger. For Trump, this is a minor setback and he intends to win.
Next, we’re going to see a lot of litigation as ballots are counted, some are rejected and accusations of fraud are tossed about. It will be highly partisan and volatile. Each step along the way is bound to inflame and upset both sides. Expect riots and protests. Thus far, the victims have mostly been storefront windows. It seems inevitable that the two sides will eventually clash in the streets. However, that violence is just the prelude.
A real investigation into election fraud takes time and with so many fake ballots now mixed in, it will be nearly impossible to reach a conclusion in the limited time remaining—in fact, it may never be solved. We’re going to run out of time. Then what? Do we have a re-vote? Do we let the states choose Electoral College winners? Do we defer to the 12th amendment (Google it as it’s about to become very important)? These are all highly partisan decisions that will mostly be made in states controlled by Republicans at the state level. If we go down this path, it will infuriate about half of our country and lead to further riots and chaos. Remember, these people were out celebrating last week, they’re not going to take a reversal of fortune lightly.
What if Trump does not get what he wants? I have a strong sense that Trump isn’t going anywhere. If you know anything about how Trump negotiates, he always starts with a very unreasonable ask and then walks it down. In this instance, he has multiple nuclear options to choose from. There’s also a chance that events could overtake Trump depending on what his own supporters do. In summary, I can see multiple event-paths over the next few weeks, many of them are not mutually exclusive and most of them are not favorable to equity markets. We haven’t had a true succession crisis in America in a very long time—the market certainly isn’t prepared for it. If anything, the market is dreaming of yet another round of stimulus, which certainly isn’t coming until we know who’s in charge.
I’m an optimist who always tries to look on the bright side of things. It has helped me to buy dips over the years when outcomes looked the darkest. I’ve also coined the “Project Zimbabwe” concept where you can be irresponsibly long because the Fed has your back. At the same time, I also try to be pragmatic about avoiding potential washouts. Leading into COVID, I was clear that it was time to de-gross. I did the same going into the election and took my exposure way down. Over the past few days, I’ve hacked a few thousand bps from my remaining exposure. At this point, I don’t have much on except my core positions that are plays on inflation, volatility and chaos (Bitcoin, JOE, Housing, Tankers). Along the way, I sold some great growth companies and some deep value names that felt silly cheap. I almost always defer realizing taxable gains until January, but this week I made a rare exception. I recently wrote about My Trump Trades. Given the pending crisis, I tossed both Alliance Resource Partners (ARLP – USA) and CoreCivic (CXW – USA). I actually made a few cents on each, which is how Event-Driven catalyst trades are supposed to work—even when wrong, you don’t lose bad or even make a bit, while playing for multi-bagger upside.
In summary, I have the least exposure I’ve had for many years. I refuse to short “Project Zimbabwe,” nor have I added much in the way of hedges. I am just de-grossed to the extreme and what’s left in my book is long inflation, volatility and chaos. I don’t want you to think that I’m calling for a civil war. I think that cooler heads will ultimately prevail. At the same time, I wouldn’t be surprised if something shockingly crazy happened first. The US has always had an equity risk premium due to stability—we’re in danger of losing that premium and there’s a long way down for risk assets trading at all-time high valuations. I think there’s a good chance that we muddle through the pending crisis and this post will look foolish in retrospect, but there’s also a small chance that it all goes horribly wrong—why risk it?
Disclosure: Funds that I control are long GBTC, JOE, CNR, short ARLP puts, short CXW puts and long CXW calls.
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