Violent policy cycles complicate decisions for consumers and investors.
“If the US Federal Reserve wishes to avoid a return to stagflation, it must recognize the huge gulf between the level of real interest rates under former Fed Chair Paul Volcker and the current incumbent. It is delusional to think that today’s wildly accommodative monetary policy can solve the worst inflation problem in a generation.“
Stephen Roach.
Consumers and investors have had to react to a new economic paradigm in 2022, as initiated by yet another extreme shift in central bank policy. It is becoming increasingly clear that central bank policy is not working well as measured by increased market volatility and ever increasing misses in their forecasts and objectives. Investors will have to raise their game.
Consumers were flush with cash in 2020 and 2021. This followed the stimulus checks which pushed the personal savings rate to all time highs.
Now, all of sudden, the savings rate has crashed down to the lowest levels since 2008. Inflation has exploded and the decline in real income together with the biggest rise in the cost of living for 40 years has stretched their resources in the opposite direction.
Consumer Sentiment has fallen to new 40 year lows. So below 2008 levels!
So sudden has this reversal been that consumers are now so stretched that credit needs have exploded, just as interest rates are rising.
“In April, card balances rose 19.6 percent on an annualized basis, following a whopping 29 percent (revised) rise in March and 11.5 percent growth in February.”
Bankrate
The situation is now so bad that real retail sales volumes have fallen to levels only seen in 2008 over the last 20 years.
The chart below shows how extraordinary economic policy became over the last decade. Outside of World War II, nothing comes close to the combination of economic support from interest rates, federal debt, and especially money supply. Now that we have seen the chaos of this policy approach, without any growth benefit it is unlikely that this will be repeated. Surely policy makers must realize that these policies have only generated inflation, and LOWER long term growth. This should be obvious from the experience of the last 70 years as described in previous insights.
Certainly, CEOs can see the problem they are now facing, in terms of the economic whipsaw.
There is also another dimension to this. After 14 years of persistent policy overstimulation, investors and corporate managers have become conditioned to abundant liquidity at record low interest rates. It has become unnecessary to make a profit as balance sheet pressures have largely disappeared. Never before has is been so easy to survive with negative net earnings. So we now have more companies like this than ever before! The fallout from the now tougher policy settings could be considerable.
Investors should also be aware that equity valuations also have not adjusted to higher inflation. The chart below shows that the high valuation dots at the top of the chart are all since 2014. In the context of the last 150 years, higher inflation levels generally have far lower valuations. Less than half of current valuations!
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Summary
Policy excess and violent shifts in policy have created an environment of increased volatility, with higher frequency and scale in economic cycles, as well as valuation distortions. Taken together with negative real interest rates and challenging long term expected returns, investors need to understand that this has become a new investment paradigm.
Economic policy has reached a crossroads, as ever more excessive intervention has reached its limits, and left the economy and markets in a challenging predicament.
Investors need Best Investor standards more than ever. In this environment, successful asset management has become a scarce resource
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