Wham! on June 8th2020 NYC announced stage 1 “reopening” after 13-week COVID lockdown, permitting curbside pickup from retail outlets; if you had said then that two years later US retail sales would be up 67%, unemployment would fall by 17 million, inflation would surge from 0.1% to 8.3%, oil would soar from $12/b to $120/b, that a pandemic would be followed by war & famine, you would have been thought utterly mad; but that’s what happened; 2020 marked a secular low in inflation & yields, the beginning of regime change and a decade of social, political, economic & financial volatility.
The Tale of the Tape: BoJ last central bank left fighting the last deflation war (the”Shoichi Yokoi” trade*…yen-14% YTD); Kuroda vowing unlimited bond buying to defend YCC policy which in past 6 years has led to…wait…0.0%Japan GDP growth & 0.2% CPI; investor “policy incredulity”= yen collapse = (Asia FX war) =BoJFX intervention = capital repatriation to Japan = potential catalyst for summer global risk-off trade.
There are 1868 words left in this subscriber-only article.
The Biggest Picture: Europe…one currency, many interest rates (Chart2); EUCPI =8.1%, PPI =37.2%, so ECB boldly decided to…not raise rates, leaving policy rate at-0.5%, and continue QE until July 1st; ECB did not “wake up” and “go-go”…Greece 10-year>4%, Italy 5-year yields threatening 3%, BTP-Bund spreads >200bps; markets stop panicking when policy makers start panicking; not enough inflation panic yet, policy credibility waning, higher risk premium required, why no bid for risk assets.
BofA Bull & Bear Indicator: falls to 0.3 from 0.4, more deeply in “extreme bearish”territory; latest buy signal for risk assets triggered May 18th.
The Bear: 33% of MSCI ACWI (952 of 2910 stocks) currently trading below their 2018 highs, 40% of Nasdaq (1496 of 3760 stocks) trading below their 2018 highs; global equity market cap peak to trough down $23.4tn since Nov’21 = 1 US economy (US GDP$24.4tn); distressed EM bonds trading at the Lehman/GFC lows of 2008 (Chart6).
Where my Bear Market Rally gone? credit & stocks so oversold, Bull & Bear Indicator is deep “contrarian bullish” territory, so why SPX from 38k to 42k and now back to 40k?…
•In short, inflation shock not over, rates shock just starting, growth shock coming, no release valve from peak in yields, bear market rally too consensus.
•Inflation: geopolitics, end of globalization, extraordinarily misguided G7 energy policies across the G7 = 2 standard deviation commodity shock unlike any other since 1973/74.
•Recession: we’re in technical recession but just don’t realize it; US Q1 GDP-1.5%, Atlanta Fed GDPNow forecast forQ2 just 0.9%, a couple of bad data points away from“recession”; consumer data getting murkier (Charts7-9 on housing, retail inventories and consumer credit); household and consumer balance sheets point to shallow recession, what can turn shallow into deep is the great unknown of the shadow banking system.
•Stagflation: we say growth returning to trend, but inflation won’t…stagflation incompatible with“goldilocks” SPX PE of 20x past 20 years…should be closer to 20th century PE of 15x.
•Events: the occasions (all of which saw BofA Bull & Bear Indicator at 0–Table2) when v bearish sentiment not enough to turn markets were 2 standard deviation events caused “liquidations”…WorldCom Jul’02, Lehman Sep’08, US debt downgrade Aug’11, China devaluation Aug’15; nagging worries that QT just beginning, to expose fragilities in EM, crypto, tech, VC/PE, risk parity, CTAs.
The jury is still out for me on secular inflation. But that’s neither here nor there right now. This crash is on like Donkey Kong as the Fed must break oil.
How it is going to do so, readers will be familiar with. It is going to squash the US consumer and send an inventory destocking shock around the trading world. Morgan Stanley’s Michael Wilson:
Equity valuations have corrected a lot this year but this is all due to higher inflation and a more hawkish Fed. Conversely, the Equity Risk Premium does not reflect the risks to growth which are increasing due to margin pressure and weaker demand as the consumer decides to hunker down.
Commentary from our analysts…our monthly meeting focused around inventory and the health of the consumer. Everyone agreed the low income consumer is already facing challenges. This lines up with the latest results from our Alphawise Consumer Pulse Survey which shows these consumers are expecting to reduce spending over the next 6 months. Analysts across different industries also commented that supply chains are loosening and inventory is building. This build is currently most challenging for retailers, but we expect this to broaden out over the coming months. The next shoe to drop is a discounting cycle—a key risk to margins, particularly for Consumer Discretionary goods.
Consumer sentiment in the US hit an all-time low last week largely driven by high prices…Interestingly, this collapse in consumer sentiment has also been present among higher end households, indicating the pervasive reach of rising inflation. Goods purchasing intentions are plummeting alongside this fall in overall household confidence. This dynamic has negative implications for goods consumption. This drop in sentiment not only poses a risk to the economy and market from a demand standpoint, but coupled with Friday’s CPI print, likely keeps the Fed on a hawkish path to fight inflation—i.e “Fire” AND “Ice”.
Buybacks were at record levels in 2021…with S&P 500 companies repurchasing $882B in stock. We take a handful of approaches at estimating 2022 buybacks with results near $850B to $1T. 2022 has been a unique year with cost pressures pushing down on corporate margin expectations for many sectors and posing a risk to EPS estimates, in our view. A key question for investors is whether corporates continue buybacks to support their stock at cheaper levels, or conserve cash as a precautionary measure? Our work shows that CEO confidence is historically a pretty good indication of both EPS and buyback trends,and suggests the latter outcome.
Check out what happened to inventory levels during the past three global recessions. This drawdown will be a huge trade shock for China and Europe.
All we need now is the credit event (or equities crash) to shock the US consumer to a standstill and full-blown global recession is here.
MB Fund is still very underweight equities, accumulating bonds as they sell and holding oodles of cash for the bottom.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
