Six Months From Now, We’ll Know Who Was Disastrously Wrong

In the absence of universal consensus around a view that turns out to be correct, somebody is always wrong.

And when it comes to predictions about asset prices and the economy, “somebody” is usually a lot of somebodies.

So it won’t exactly be surprising when we look up in December and discover that quite a few, if not most, of the predictions analysts, economists and their armchair doppelgängers, made six months previous (i.e., now) turned out to be wholly erroneous.

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But it’s starting to feel like a muddle-through scenario defined by, say, a mild second wave of COVID-19, a notable (but not catastrophic) rise in credit events, a sluggish (but not totally moribund) recovery and some reasonably sane US election outcome, is less likely than either of the two extreme scenarios.

By “extreme” scenarios, I mean the following (I call them “extreme” because they would likely entail dramatically divergent outcomes across assets):

1. In hindsight, the COVID-19 panic looks more like a growth scare than a crisis, the economy quickly recovers, there’s progress on the medical front, and the combination of unprecedented monetary and fiscal stimulus pushes asset prices inexorably higher into an election that goes off without America becoming a banana republic
2. The virus returns in a serious way, the damage to the economy from the shutdowns proves to be structural, aggregate demand wanes after an initial rebound, employment resets sustainably higher as some job losses prove permanent, and the election is marred by domestic upheaval and a disputed result

It seems to me that the subjective odds of either of those two scenarios playing out are at least equal to the odds of the muddle-through scenario materializing.

If one of those two extreme scenarios does, in fact, unfold, lots of folks are going to be proven dramatically wrong to a degree that will be at best, embarrassing, and at worst, career ending.

Look where we are. US equities are up 40% in 50 days.

This has a decidedly binary feel to it.

One side of the argument says you’re a moron if you don’t sell now to lock in gains after stocks staged a ~40% surge in a matter of two months during the middle of a modern day depression.

On the other hand, it’s possible to argue that you’re a moron if you’re not buying hand over fist right now, because we’re still off the highs and G4 central banks are seen increasing the size of their collective balance sheet by nearly $13 trillion by the end of next year, partly to accommodate a massive global fiscal impulse that in many cases includes direct payments to households.

(Morgan Stanley)

Bloomberg’s Sarah Ponczek had another solid piece out on Wednesday evening in the US. If you don’t follow her, you probably should – she’s got a gift for penning posts that sweep the reader along from beginning to end in what feels like no time, one hallmark of a good writer.

“The most vocal optimists are getting skeptical of the never-ending stock rally”, she begins. “With $7 trillion in value created and the Nasdaq 100 near a record, many big bulls are sounding distinctly…bearish”. The gist of the article is that even optimists are wary of recent gains.

To be sure, some analysts have spent the last couple of weeks making the case that there’s still a sizable short base that “needs” covering and that outside of CTAs and some other systematic re-leveraging at the margins, participation has been lackluster. So, it’s possible you’re seeing capitulation from bears, with every incremental piece of “good” news on the economic front rubbing salt in the open wounds of recalcitrant skeptics.

But if you can take the pain, you’re comforted in your skepticism by the fact that never in history has the word “good” been such a relative term.

I certainly never thought I’d see the day when an ADP report showing 2.8 million jobs were lost over a single survey period counted as a massive beat versus consensus. Similarly, the notion that we’d ever be giving thanks for ISM manufacturing and services prints of 43.1 and 45.4, respectively, would have seemed wholly bizarre just four months ago.

At the same time, it’s important not to be so fixated on the crash (and let’s face it, some of these prints are so bad that it’s impossible to resist the temptation to rubberneck it as we drive slowly by on the highway) that we start making decisions based on what’s already happened and not what we think is likely to happen next.

The risk for skeptics is overestimating the structural damage and underestimating the impact of the fiscal and monetary impulse. SocGen calls the fiscal side “a public spending blitz of unheard proportions”. Here’s a bit more:

The magnitude of the likely fiscal expansion is simply monumental (see chart below). For example, we expect national public-sector deficits to jump in 2020 compared with 2019 by about 6pp of GDP across the euro area economies in aggregate, by 9pp in the US, by 17% in Japan, by 12pp in the UK, etc. Admittedly, part of this increase is caused by the cycle (i.e. automatic stabilisers), but it would still be a massive effort if achieved. In fact, the contribution from automatic stabilisers and the change in the fiscal stance (i.e. the discretionary policy contribution) is now very hard, if not impossible, to determine. The reason is that automatic stabilisers have been boosted in many economies, for example by adding furlough schemes to existing unemployment benefit payments. These are by nature also ‘automatic’, but they were, at the same time, a new fiscal policy easing. The same could be said for schemes aimed at business finances.

As ever, the crucial point when it comes to the COVID policy response is the coordination between monetary and fiscal policy and, just as important, the extent to which officials are becoming more comfortable using terms synonymous with “coordination” to describe the joint effort.

SocGen brings this up as well. To wit, from the same 120-page quarterly economic outlook:

While avoiding the emotive term monetisation (the meaning of which has become increasingly blurred in recent years, anyway), some central banks have in fact been explicit that their public-sector asset purchases are, at least in part, calibrated by the expected increase in issuance stemming from public spending measures. For others, the message is more implicit. The point is that central banks are actively ‘working’ government bond markets to smoothly absorb the new issuance.

We all know why it’s risky to buy equities trading at 25x forward earnings when nobody is sure whether there will, in fact, be any earnings.

While things are looking ok on the virus front now, in the event there’s a second wave that spreads globally and forces another lockdown, you may unwittingly be paying 40x or 50x or 70x or infinity-x, for shares of a given company.

In the same vein, we also know it’s risky to be long risk assets after a jaw-dropping surge when the economy is still struggling mightily.

But, it could be even more risky to be bearish at the dawn of a new era for monetary-fiscal cooperation.

In the simplest possible terms, if monetary policy and fiscal policy start working together in harmony, there will probably be a time period between now and some indeterminate date in the future when critics swear hyperinflation will kick in, during which the economy booms.

Good luck staying on the right side of this. And I mean that sincerely. Good luck. Because, as alluded to above, if you’re responsible for managing other people’s money and you screw this up, it’s probably lights out.

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