“Fast-changing headwinds and risks to the economic outlook have increased since the start of the year,” Morgan Stanley’s Ellen Zentner ventured, in the bank’s mid-year economic outlook, released this week.
It’s fair to call that an understatement. Her colleague Seth Carpenter captured it better last week, when he described the current macro conjuncture as “the most chaotic, hard-to-predict” environment in decades.
A look at YTD cross-asset returns betrays across-the-board malaise. Government bonds are down nearly 12%, the same as junk, which the sarcastic among you might suggest is apt. Investment grade corporate credit is off by double digits and global stocks are teetering on the brink of a bear market. Many benchmarks are already there. Bitcoin and Ethereum are down more than 50% from the highs. And gold can’t catch a break — it failed to launch despite the highest developed market inflation in four decades and now it’s at the mercy of rising US real rates and a concurrent rally in the dollar. Commodities are the only diversifier that’s worked (figure below).
India’s decision to impose a ban on wheat exports is likely to upend raw materials anew. Although regionalization and food protectionism were already in full swing, India’s moratorium felt more consequential. I’d guess markets will reflect that.
Politicians are becoming desperate. US lawmakers are engaged in a Monty Python-esque effort to identify “price-gougers” who, it seems, will be dressed as witches and presented to Joe Biden. “We have found a witch!”
To be clear: I don’t doubt there’s opportunism afoot in America. What I do doubt, though, is the idea that trying to sort out who’s gouging who for what and where is going to have an impact on nationwide inflation aggregates.
In any event, stagflation (or some version of it) is becoming the base case across the developed world. The European Commission is set to cut its GDP outlook and almost double its inflation projections for the euro-area in new forecasts to be released on Monday (figure below).
Growth will be 2.7% this year and inflation 6.1%, according to a draft document. February’s forecasts called for 4% growth and 3.5% inflation. Do take a moment to marvel at how dramatically misguided the February forecast (green line in the chart) turned out to be.
Obviously, the risks are skewed to the upside considering efforts to curtail, or cut off, Russian energy flows. The ECB has to hike rates in July. Like the Fed and the Bank of England, they have little choice but to tighten into a burgeoning slowdown.
Meanwhile, market liquidity is abysmal, and that’s exacerbating price swings. The simple figure (below) underscores the point.
“S&P 500 futures top-of-book depth now nearly matches the lows reached in 2008 and 2020,” Goldman’s David Kostin remarked on Friday.
And it’s not just stocks. “Liquidity conditions have been poor since the start of the year and are deteriorating again in equities, US Treasurys and volatility futures,” SocGen’s Sandrine Ungari said, noting that the bank’s trading liquidity indicators, which track the ratio of the average dollar volume of futures that can be traded at the best price and average daily volume, suggest liquidity is “drying up” for stocks, bonds, vol and oil.
Little wonder most days feel like the blind leading the blind. As one CIO told Bloomberg’s Lu Wang and Liz McCormick, “It all goes back to last year because in order to get any forecast right, in stocks, rates and other assets you needed to have your inflation forecast right. And nobody got that right.”
Well, almost nobody. “The ‘price-gouging at the pump’ stuff is to economic[s] what President Trump’s remarks about disinfectant-in-your-veins was to medical science,” Larry Summers sighed, during a chat with Bloomberg’s David Westin.
Summers, who Bloomberg pays for his “contributions,” was characteristically forthright. “There is no material prospect that… gouging legislation can have any substantial effect on inflationary pressure,” he said. “But it can cause all kinds of shortages.”
The truth be known price gauging has been going on at the corporate level for decades at least but in the name of productivity enhancements. Now that everyone else has gotten into the ‘ game ‘ ….well I guess we have a name change to price gauging.. No surprise to me !!
In the 1970s, I reminisce, we had an oil embargo, historically high gasoline prices, rationing and excess profits taxes to punish the gougers. Big oil took their profits and bought all kinds of silly stuff to avoid the tax — Mobil bought Montgomery Ward soon before its bankruptcy, for example. Price controls were also enacted to put a cap on oil prices and everything else soon after. The depletion allowance as eliminated for major producers. Still, none of this really worked and we needed Volcker to fix everything .. finally.
Probably, at the risk of some derision, I would argue that the inability of firms to engage in price gouging over the 10-15 years is a major driver in the price rises of today. The pandemic, and the shortages it created, provided needed cover for companies wanting to raise profits and restore margins. As in, who’s going to care about a 15% rise in the price of toilet tissue when they haven’t been able to stock up for weeks and finally score a bunch of giant rolls? Those less fortunate among us who eat a lot of hamburger helper need the burger even if the price goes up. That’s elasticity, folks, an economic quirk that’s easy to forget.
Here is a January 2022 note from Bryon Wien of Blackstone, on the ten biggest surprises ahead in 2022. A “big surprise” is something big that the average investor thinks is less than 30% probable but that Wien thought was at least 50% probable.
https://cdn.circle.so/z9v481cfkg4uvez21m1o8vsix475
Wien’s hit rate is good so far in 2022. Admittedly he didn’t publish the note until January, when many of these things had, in my opinion, been looking very likely for some time – but this is an annual note he writes in January, and he likely was anticipating these things before then, and he was also writing before Russia invaded Ukraine.
What is interesting is that, if he is right, the “average investor” thought all of these things were quite unlikely all the way up to the January 2022 market peak.
(Which would seem corroborated by the fact that the market peaked in Jan 22, not in June 21 or another earlier date.)
Now to go see if BX funds’ investment performance reflect Wien’s views, i.e. if money was put where the mouth was.