Despondent investor psychology and ostensible evidence of “peak inflation” aren’t a bad setup for a bear market rally, but policymakers aren’t likely to countenance it.
“Central banks are the oncoming freight train,” BofA’s Michael Hartnett said, in his latest. The Fed and its peers “will tighten until credit and/or the consumer break,” he added.
Certainly, policymakers seem serious. They’re talking the talk, but they’re also walking the walk, as the clichéd old adage goes. New Zealand’s “path of least regret” is increasingly the preferred trail, as Canada demonstrated just hours after RBNZ delivered its first 50bps hike in decades. Since then, speculation for a summer ECB hike kicked into overdrive, while US rates explored new ground in search of a Fed cadence that sounds totally alien to the vast majority of market participants.
Hartnett called that “the charge of the hike brigade.” So far in 2022, markets have endured 75 global rate hikes, which translates into the highest net % central bank hiking since 2008 (figure below).
Of course, we’re a long way from unwinding the net easing witnessed since Lehman, which sums to more than 1,000 rate cuts and more than $23 trillion of asset purchases.
The road to higher rates won’t be smooth, Hartnett warned, before declaring that “the era of higher volatility has begun.”
2022’s inflation shock “demands that the coming quantitative tightening is draconian,” he went on to say. That doesn’t bode well for the companies on whose shoulders an equity bubble a dozen years in the making rests (figure below).
Correlation isn’t always causation, but it is here. Or, at least, we can employ another old adage: There are no coincidences.
There’s a growing sense that something, somewhere is about to “snap.” I’ve used that admittedly nebulous line while describing USDJPY’s epic ascent driven by a rapidly growing policy divergence between the Fed and the BoJ, which SocGen’s Albert Edwards highlighted on Friday.
For his part, Hartnett said the MOVE above 150 and the dollar index above 105 would mean a credit event is “imminent.”
We’re not too far away from those supposed thresholds (figure above).
If copper were to break down, oil were to trade sustainably below $95 and the SOX were to close below its 200-day moving average, that would “imply growth taking a turn for the worst” which could “incite a rotation from the last cyclical holdouts to defensives, including utilities, staples, healthcare, low volatility, high quality” and, in the final, desperate act, USD cash, Hartnett suggested.
“Happily,” cash may well boast a handsome yield at that point. Remember: Cash was the best-performing traditional asset class on the planet in 2018, the last time the Fed tried double-barreled tightening.
The problem in 2022 is that barring some extremely fortuitous turn of events, there’s virtually no chance your (suddenly viable) cash position will post a positive return when adjusted for inflation.
Don’t just focus on listed stocks and bonds. Wait until our friends in private equity and credit are forced to mark their assets down closer to reality.
For a few years every ETF vendor has been pushing “alternatives” of all kinds. Alone that might be no big deal, but the consultants to pensions and endowments have been singing the same melody. The amounts waiting to be marked down are not trivial.
But the Fed models say that is no problem, so I am not worried.
They will have to call the Tidy Bowl Man out of retirement to clean up the mess when they are done!
The soft landing is increasingly looking like magical thinking. When things turn they turn fast. It certainly feels like an inflection point. The moment of truth will be if the volatility translates into a bear market and has contagion into the real economy. When/if that happens you will see policy change again. That probably won’t be evident until later this year at the earliest. In the meantime, my guess is Bank of America is correct, we are going to see greater volatility in financial markets.
What soft landing? Looks like the Fed is trying to see how nasty it can get … and as fast as possible.
I think the thing I like the least about the world I’m currently dying in, is that it has completely lost its patience (and its collective mind). The Fed is in the woods for ten years and now it’s suddenly awoken like Rip Van Winkle and decided it has to fix everything in the next ten minutes … running around like the Mad Hatter, “I’m late, I’m late …
And it’s not just the Fed. Half the world is trying to ignore climate change and the other half has decided we have to get rid of oil and evil cars and power plants, all by 2025. Seriously? Who are these people? None of these “emergency” moves will work, or as those who propose this stuff hope, none will provide any serious political benefit. All the late-to-the-party, we-gotta-change-now people just want to say they fixed all the big problems so they can go back to their cell phones and FB pages and be able to avoid actually thinking any more. As I keep telling my daughter, even though it makes her angry, I am so glad I’m old.
I have a book on my shelves about the onset of the Industrial Revolution with the title, “Pandemonium.” That’s what happened then and will soon be happening again. I’m sorry for those who will be going through the coming big changes because Mars will not actually be available to the 8 billion who might want one of those nine-figure tickets. We are here and here we will be staying. Musk talks wistfully about Mars to keep up his reputation as a visionary but as recent events have shown, he is really only interested in himself and being President (Twitter, why else?).
Happily, Mr. Musk is ineligible to ever serve as POTUS. That may be the only bright spot in your otherwise believable forecast.
I truly enjoyed your rant Mr. Lucky. I remember when a bottle of Coke cost five cents and I was apprehensive about the future because I learned that Eisenhower would be leaving the presidency after his second term. But to the amazement of my parents, who had a house full of rug rats during the depression, it all worked out. We survived $2.49 bottles of Coke and the financialization of the economy. The kids can work their way through its feudalization or find a better path forward.
Should think about what kind of a recession it’ll be. Hot job market and labor shortage suggests the people who usually suffer the most in recession might get off easier this time. Big asset owners (stocks, PE, RE) may have it worse, but even a pretty meaty decline from here would still be a decent 3 year return – unless you’re a Cathie Wood follower, overexposed to certain kinds of office RE, etc. The biggest hit might be to the “middle class”. Companies are enjoying very high operating margins, and will defend them by cost-cutting. Look for waves of middle manager axings.
So, questions from a semi retired person trying to manage their nest egg— where does one monitor bond volatility and dollar index? How does one determine when private equity is forced to sell?