Welcome to the festive season! The FTSE 100 is falling sharply, we may have a hard Brexit any day now, a new variant of the virus is spreading ‘out of control’ in Essex and the country is now officially quarantined by all our closest travel partners. Oh, and the queue is long and getting longer by the minute at my local Waitrose.

Just to add to the misery, I would be willing to lay down money that fairly early in the New Year we’ll have another stock market correction. The cause is of course unknowable but the way I see it, there are two possible contrasting scenarios. The first is that real-world economic data surprises to the upside, which sparks more concerns about central banks tightening ahead of inflationary pressures. The alternative scenario is that the virus springs us some more nasty surprises (?!) in January and February, which places the incoming Biden administration in a right pickle. And I suppose there’s always the outside chance that Trump could surprise us yet with something even more stupid than we all expect.

In truth the cause of any sell-off is probably a bit irrelevant – most major bull rallies usually turn at some stage. The excellent Variant Perception put out a blog last week which reminded us that there might be parallels with both 2009 and 2017. You can see their cogently argued piece online here: https://www.variantperception.com/2020/12/17/comparing-todays-markets-with-2009-and-2017/

They remind their readers that in 2009 “equity markets rallied against a backdrop of a terrible economy, but rising leading indicators and strong policy stimulus. The rally extended until January 2010, before the S&P experienced an 8% correction in February 2010.”

CHART 1

Then in 2017, “the S&P rallied through the year with minimal drawdowns, against a backdrop of fiscal stimulus (Trump’s tax cuts) and the Fed, under Janet Yellen, hiking rates very cautiously. The 2017 rally extended into January 2018, before a -11% correction in February 2018. Given the analysis we presented to clients recently on seasonal equity inflows in January, it seems plausible that today could see a similar pattern, where markets keep grinding higher into January 2021 and we see a correction in February.”

CHART 2

The pleasant sting in the tail of the Variant Perception analysis is that 2021 might not repeat this miserable pattern. A retracement is “but it is not our base case, given today’s underlying strong macro, and strong liquidity growth.”. I’m not quite so certain and I’d wager we have a 5 to 10% correction.

And if that correction does come there has to be a decent chance that Tesla might feature in the sell off. I have no fixed view on the electric leviathan except the banal observation that it looks a bit expensive. Then again, that’s not an original insight and a much better analysis comes from the notorious contrarian investors at Research Affiliates who’ve run their slide rules over Tesla. You can see their results here: https://www.researchaffiliates.com/en_us/publications/articles/819-tesla-the-largest-cap-stock-ever.html

In a paper by Rob Arnott, Vitali Kalesnik and Lillian Wu they remind their clients that Tesla is entering the S&P 500 with a stupendously high valuation and will likely be ranked sixth in the index. Their warning is that Traditional cap-weighted indices, such as the S&P 500, are structured to buy high and sell low—” and Tesla is a prime example of this maxim”.

“The eightfold increase in Tesla’s share price since its March low meets our two-part definition of a bubble: 1) implausible assumptions are needed to justify its valuation, and 2) buyer interest is based on a great narrative rather than being supported by a conventional valuation model.

Our research shows that a continuation of Tesla’s 2020 share-price performance is vulnerable on two additional fronts: 1) as a top-dog stock (top 10 market-cap stocks), the odds are against its remaining a top-dog stock, and 2) as an addition to the S&P 500, history indicates it is likely to underperform the market (S&P 500) in the year after entry.

Our research also demonstrates that Apartment Investment and Management, the stock removed from the S&P 500 to make way for Tesla, is likely to outperform the index over the next year by as much as 20%, based on the average outperformance of all deletions from the index in the 31-year period from October 1987 through December 2017”.

CHART

I’ll finish with one last miserable aside. The master Permabear Albert Edwards has alighted on the UN’s Food and Agriculture Organization’s (FAO) widely followed food price index which has “once again – been surging over the last few months (the basket measures prices for oilseeds, dairy products, meat and sugar). Reuters reports that the FAO food index rose for a sixth month running in November, almost hitting a six-year high. Annual inflation in cereals reached 20%, the highest annual rise since mid-2011 when the Arab Spring was in full flow! (see chart below). At a time when the World Bank notes that the Covid-19 pandemic will increase extreme poverty by around 150 million (link ), we all need to be very vigilant of another food price bubble.”

This observation reminds us that although we are all collectively obsessed with developed world inflation prospects – see last week’s Economist on the subject – the real geopolitical danger is rampant inflation in emerging markets, which could cause political mayhem, again.

CHART