Historically Extreme Macro Conditions

November 11, 2022

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If You Don’t Do Macro, Macro Will Do You

“When people panic, they make mistakes.”
Ryan Holiday

“It’s easy to stand in the crowd but it takes courage to stand alone.”
Mahatma Gandhi

Last week’s leading indicator charts showed how far cyclical stocks are lagging the weakness in the data. This week the focus is on the likely depth and longevity of the current period of declining growth and the scale of the stock market and house price correction to catch up with the economic downturn.

The CPI data was welcome news this week, but it was not outside the range of expectations and is a single data point. The key macro point is that even if we now have both declining growth AND declining inflation, that is the worst case environment for the stock market, particularly while interest rates are still rising.

Last week cyclical stocks were the focus, but many other sectors look as though corrections have further to go, and housing is a major component of the economy.

House Prices Also Seem To Be Lagging

30 year fixed rate mortgages have gone from all time low level to multidecade highs just this year. No wonder house prices have reversed downwards. On some measures the speed of decline in prices is the fastest pace since the 1940s. However, the chart below shows that, relative to mortgage rates it looks like just the beginning of the house price correction.

Economic And Policy Extreme

Today, over 80% of Countries around the world likely have declining economic growth in the next 3 Quarters, based on the most reliable projections, while over 80% of central banks are raising rates!

For the last decade and more, while inflation concerns were absent, the standard central bank response to weak growth was a significant cut in interest rates. As I stated in my Money Show video in October 2021, inflation was a game changer for the economy, markets and policy. The central banks finally realized this in 2022, and have been raising rates all year even as growth has continued to weaken.

Their attempts to rein in inflation, however, are likely to create the next problem. Reinforcing a massive global downturn in growth with relentless interest rate rises is likely to produce a significant global recession. The economic data is clearly moving in that direction.

Record Rising Bond Yields Take Equity Yields To An Expensive Extreme

The record collapse in the bond market this year has taken the stock to bond yield relationship back to an extreme. It has never gone beyond this point! Think carefully about the years in which this ratio was reached and what happened thereafter.

The US 10yr detrended Bond/Equity Yield Ratio is at levels seen in 2000, 1981, 1968, 1955 and 1929. Peak to trough losses seen over the subsequent 5 years were -25%/-75%. This is no time to be bullish!
John Authers

Rising bond yields have caused other problems. The chart below shows the explosive growth in debt in the last decade, which seemed relatively costless at low interest rates. The red dot shows the sudden dramatic change in interest rates this year compared to the blue dots.

This creates another problem. The chart below shows the gradual rise in interest payments on the debt over the last decade. If debt will be rolled forward at the current 1 year rate, you can see what happens to total interest payments on Federal Debt.

The scale of government debt is straining the ability of the private sector to provide sufficient captal.

‘The amount of government debt that will need to be absorbed by the private sector in the coming months is larger than at any time outside of world wars (when the central bank engineered a safe risk premium on bonds) and the global financial crisis.’

Summary

Investors need to think differently in an inflationary environment. That’s because the central banks have to conduct policy differently or lose control of inflation and the cost of financing ever expanding debt.

It would be helpful if the central banks could get some assistance from fiscal policy, but overall there is little sign that politicians will deliver on this score. As best as we can tell there is little prospect of any change in excessive government spending post the mid term elections. Both sides of the aisle have made a contribution to this growing challenge and there does not seem to be any change likely even as another debt “ceiling” approaches.

Investors need to be aware that declining rates of change in both inflation and growth is the worst environment for equities, equities are at historic extremes relative the government bonds, government bonds still have a range of challenges limiting the potential for a sustainable rally, and interest rates are still rising.

Transform Your Investment Experience

The room for policy manoeuvre, and the stability of the current system should not be taken for granted. Volatility has increased and is likely to continue to stay high. The outlook has rarely been this uncertain. Investment management needs Best Investor metrics and techniques as never before.

Market and economic events are moving fast at this stage. If you need a quick review of the issues that you may need to know about for your own circumstances, schedule a FREE consultation today.

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