Latin for the machine in reverse, contra machina, sums up our current dilemma. In January, the Fed laid out a plan to raise rates and slow money printing while reckless fiscal largesse was shut down by Senators Manchin (D, WV) and Sinema (D, AZ) and the SPp500 peaked. But money continued to pour into yesterday’s free-money winners like Cathie Woods’ ARKK, obscure crypto coins, and venture capital unicorns. By March, the Fed stopped all printing, worried about inflation, and we had our first real wave down as Putin’s war all but guaranteed a longer inflationary impulse. Nevertheless, ETF flows stayed positive as the Russia-Ukraine war was dismissed as a short term ‘isolated’ event.

The Fed exit left the bond market to find its own price level – bonds crashed. Now, on June 1, the Fed will start reducing their historically bloated balance sheet. They plan to drop about $1Trillion per year. The bond market will vote on those prices soon. According to Bloomberg data, ARKK is down nearly 60% YTD, Luna Crypto Coins which peaked in Mid-April just traded below zero, and on and on. Wake up, we believe its contra machina, the machine is running in reverse and it’s not a pretty picture for risk assets.

As a Chemical Engineering student, I studied lots of calculus to try to understand Thermodynamics and Physical Chemistry (not sure I ever really got PChem). But, when I got to Wall Street, I realized no one talked about Calculus. Most investment theses were narratives on recently biased linear trends to infinity either up or down. I fell victim to that in 1987, when near the bottom of the December stock market retest, I thought we were headed straight into a Great Depression – Not! Lesson learned! Recently others straight-lined the growth for Netflix, Peloton, Wayfair, etc., etc. In these cases, people missed the change in the first derivative (that pesky Calculus thing). No equations here but realize the governing factor is simply that the rate of change inflected direction. And when the second derivative increases you start to pick up steam in that new direction. In 2020, the economic machine, call it nominal GDP, was inflected positive and accelerating. Now, contra machina, the rate of change is negative and getting worse. Understanding this will not necessarily get you an A in Thermodynamics (it’s a tough course) but it could save you a lot of money in risk assets till it inflects back positively.


It is rare for the Federal Reserve to be tightening into an economic slowdown but their mistake on inflation by monetizing obscene deficit spending and then looking the other way was unique. So, now risk assets must deal with higher interest rates and a rapid withdrawal of liquidity. That arrow is pointing down and accelerating. Early lead indicators of the economy are all inflecting negatively now – housing, consumer confidence, inventory bloat, CEO confidence. But Wall Street hasn’t heard the message yet; SP500 earnings are still estimated to be up 10% yr/yr in the second half. Take the under on that; we will be lucky to be flat. And, if the Fed doesn’t relent by August, we will have down earnings and they could be down significantly. Just ask Walmart, Target, and Deere what a slowing economy with high inflation does to margins.

We figure the calculus of the moment is against risk assets. Pretending incorrect earnings estimates make the market cheap and is dangerous and costly. It may not be safe sailing until the contra machina slows down. That might last through the first quarter of 2023. For now, we are of the opinion that the less risk you take, the more enjoyable your summer will be.


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