Bullwhip

When Michael Burry speaks, investors tend to listen. After all, the hedge fund manager did correctly predict the 2008 subprime mortgage crisis, and subsequently gained fame as a central character in the film “The Big Short”. And now, he’s got everyone talking about a retail sector “bullwhip effect” that could cause inflation to dip and the Federal Reserve to reverse course on its interest rate hikes, which would be hugely positive for stocks and bonds. So the million-dollar question is, will the “Big Short” guy prove to be correct once again?

Macro

The week definitely started off with a bang. On Monday, Russia defaulted on its external sovereign bonds for the first time since 1998. That came after ever-tougher Western sanctions shut down the country’s payment routes to overseas creditors despite it having the resources to pay its bills. Given the damage already done to the economy and markets, the default is also mostly symbolic for now. After all, the country’s bonds were already down about 80% since February before the default. But what it could mean is that countries and companies are less likely to invest in Russia for years to come.

If we’re to listen to Carmen Reinhart, the Chief Economist of the World Bank, then Russia is probably not the only default we’re going to see over the medium term. Reinhart said in an interview on Tuesday that the list of emerging markets facing debt distress is quickly mounting as global interest rates rise. That’s increasing the cost of servicing debt, and comes at a time when EMs are already contending with China's economic slowdown as well as soaring food and energy prices, which typically hit EM populations harder. While the direct impact on the global economy of debt defaults in a few EM countries would be small, crises in the developing world have a history of spreading well beyond their starting points.

In other macro news, this week we got a bold prediction from Michael Burry – the hedge fund manager who correctly predicted the 2008 subprime mortgage crisis, inspiring “The Big Short” film. More recently, he bought around $30 million worth of put options against the ARK Innovation ETF in August, essentially betting that its price will fall (the ETF is down by more than 60% since then). And now the legendary investor has a new prediction, expressed in the following tweet.

Burry’s tweet links to a CNN story about retailers considering just handing customers their money back and letting them hang onto the stuff they don't want rather than having them take the items back. The idea is to avoid adding items to already mounting inventories, which have become a bit of a problem lately. According to research by Bloomberg out earlier this month, retailers like Walmart and Target saw their inventories balloon to $45 billion last quarter – up 26% from a year ago.

According to Burry, retailers’ bloated inventories will be deflationary (i.e. will lead to lower consumer prices) in two main ways. The first reason is because retailers will eventually have to drop prices to offload all the goods they’ve stockpiled. The second reason is because of the “bullwhip effect” – a supply chain phenomenon describing how small changes in demand at the retail level can cause progressively larger fluctuations in demand at the wholesale, manufacturer, and raw material supplier levels. In this case, retailers with bloated inventories reduce their orders from wholesalers. That reverberates throughout the supply chain, leading to reduced orders from manufacturers and, eventually, weaker commodity prices.

Burry’s key takeaway is that inflation will slow down because of these factors, allowing the Fed to pause or even reverse rate hikes. If he’s correct and that happens, it would be positive for both the stock and bond markets. Time will tell if the “Big Short” guy is correct…

Stocks

Last year was a record one for US initial public offerings (IPOs), fueled by the popularity of special purpose acquisition companies (or “SPACs”). Now, market volatility, soaring inflation, and recession fears have brought an abrupt end to the party: companies have raised just $4.9 billion via US IPOs during the first two quarters of this year. That’s 90% below the five-year average for the period. Investment banks are not feeling too optimistic either: they don’t expect the IPO market to recover this summer. That means investors will most likely have to wait longer for some high-profile IPOs like Instacart, Reddit, Stripe, and Discord.

The impacts of a slumping IPO market will be felt across several corners of the financial industry. Private equity firms, for example, will struggle to exit their investments if it’s very tough to list the firms they’ve previously acquired. Investment banks, who take a cut from every IPO they work on, will see their dealmaking revenue shrink. But at least they got one piece of good news this month: all 33 of America’s biggest banks passed the Fed’s annual stress test, which gauged each lender’s ability to weather a severe economic downturn. That paved the way for them to boost their payouts to shareholders, with Goldman Sachs and Morgan Staley announcing a 25% and 11% dividend increase respectively on Monday.

Commodities

The European Union took a historic step to phasing out internal combustion engines on Wednesday, agreeing on a deal that bans the sale of fossil fuel-powered cars by 2035. The deal will provide another boost to the European electric vehicle (EV) market once finalized. And what’s a clear consequence of more EVs on the road? Lower oil demand – something that’s already happening. According to Bloomberg New Energy Finance (BNEF), EVs will displace almost 2.5 million barrels of oil per day by 2025. In fact, BNEF estimates that total oil demand from road transport will peak in 2027.

Crypto

The NFT market has been sliding after sales sank sharply and the prices of popular NFTs plummeted in the last few weeks. Last month was the first where the market recorded under $1 billion in sales in a year, with OpenSea – the world’s biggest NFT marketplace – experiencing a 75% drop in sales volume since May. The prices of top-selling NFTs, meanwhile, have also slipped. The JPG NFT Index, which tracks the prices of a handful of blue-chip NFT projects, is down by more than 70% since its inception in April.

Next week

We’ll get Chinese PMI – a survey of business sentiment that serves as a key forward-looking economic indicator – at the start of the week, which should offer a first look into economic conditions in June for the world’s second-biggest economy. Retail sales for the eurozone is due on Wednesday, with investors nervously watching the impact inflation – which hit a record high in the eurozone in June – is having on consumer spending. Lastly, we’ll end the week with the closely watched US jobs report that’ll shed new light on the health of the labor market as well as how wages are faring in light of soaring inflation.