Last month was especially cruel to equities. September lived up to its nefarious seasonal reputation.
As Morgan Stanley’s Mike Wilson wrote Sunday, stocks’ dastardly performance this year meant the bar to clear for a “bad” month was pretty high. In that context, the S&P’s 9.2% drubbing (the worst September in 20 years) was “impressive” indeed.
“Given how bad this year has been, that wasn’t an easy call when we doubled down on our bearish view for stocks four weeks ago,” he said.
Wilson has, of course, maintained a bearish stance on equities for the better part of a year. It’s been the right call.
On Sunday, he highlighted the Bank of England’s emergency intervention, noting that although the BoE’s decision to “temporarily” support long-dated gilts was aimed at rescuing pension funds and preserving market functioning, investors would be remiss not to consider the broader implications.
“With pain this severe in certain markets, some of the cavalry has been called in,” Wilson said. “Some may argue the UK is in a unique situation and so this doesn’t portend other central banks doing the same thing [but] this is how it starts.” The emphasis was in Wilson’s original note.
This is a very slippery slope. As discussed at some length here over the weekend, there’s no guarantee the BoE will be able to sell the bonds they’re buying without impacting markets, let alone sell the newly-purchased long-dated gilts and commence QT, as originally planned prior to last week’s meltdown.
Markets have already snapped. I summed it up in “Neon Swans, Cash And A Dubious Anniversary.” The question is no longer “How long until something breaks?” Something broke last week. It was the UK bond market. And before that it was the yen. The yuan is still breaking. So is the euro. Soon enough, it’ll be credit. As such, the question is “How long before the crescendoing panic is too loud for the Fed to ignore?”
Wilson agrees. “Investors can’t be as adamant that the Fed will choose to or be able to follow through on its guidance,” he said. “Like it or not, the world is still dependent on US dollars, which provide the oxygen for global economies and markets.”
Fed officials were keen last week to suggest that overseas tumult doesn’t have immediate implications for US monetary policy, but that contention doesn’t work the other way around. Big shifts in US monetary policy always have implications for the rest of the world. Immediately.
Wilson reminded investors that the bank’s mid-cycle transition call in March of 2021 was predicated on peaking M2 growth. As it turns out, that was “exactly when the most speculative assets in the marketplace peaked and began to suffer,” he said, citing crypto, SPACs, IPOs and profitless growth shares. March of 2021 was also “peak Cathie Wood,” so to speak.
Fast forward 18 months and Wilson warned M2 growth is in the “danger zone,” a precarious tipping point beyond which “financial/economic accidents tend to occur.”
The figure above suggests M2 in dollars for the world’s four largest economies is falling on a YoY basis for the first time in more than seven years, and is projected to fall rapidly going forward. That, Wilson wrote, doesn’t bode well for stocks.
Wilson called the current tightening “unsustainable.” If it continues, it will “lead to intolerable economic and financial stress,” he cautioned, citing last week’s turmoil as an example. Although he conceded that Liz Truss’s fiscal unveil was widely viewed as the proximate cause of the meltdown, Wilson suggested “the reaction in financial markets was so extreme due to the tightening of liquidity in the global system.”
The good news is, the Fed can fix the situation with a keystroke. “US dollar supply is tight for many reasons beyond Fed policy, but only the Fed can print the dollars necessary to fix the problem,” he said.
With that in mind, Wilson posed two related questions. First, he asked when the problems the strong dollar is creating for the rest of the world will boomerang and make landfall in the US. Although it’s impossible to say with anything like certainty, Wilson sounded sure of one thing. “More price action of the kind we’ve been experiencing will eventually get the Fed to back off,” he wrote.
Then, he asked whether the Fed, once it decides enough is enough, will be able to rescue the world simply by dialing back or ending QT, or whether Jerome Powell will ultimately be compelled to restart asset purchases. In Morgan Stanley’s opinion (or at least in the opinion of the bank’s US equities team), a sustainable rally in US stocks requires the resumption of QE.
And yet, the die is cast for earnings. The profit reckoning that was kicked down the road in Q2 is likely to “realize” in Q3, with attendant guide downs and revisions, especially given the lagged impact of the stronger dollar on multinationals. It’s too late for the Fed to prevent an earnings recessions, or something that feels a lot like one.
The bottom line for Wilson is that without a Fed pivot, stocks are probably going lower. If, on the other hand, the Fed does pivot or the market becomes convinced a pivot is imminent, a “sharp” rally could ensue at some point.
He closed with a flourish: “Just keep in mind that the light at the end of the tunnel you might see if that happens is actually the freight train of the oncoming earnings recession that the Fed cannot stop.”
8 thoughts on “‘Danger Zone’ Markets Need Fed To ‘Print Dollars’: Wilson”
The light at the end of the tunnel is a fast approaching train.
Wilson is most certainly correct about the likelihood of spillover and the trajectory of markets going forward, but his analysis begs the question: How much longer will ordinary, tax-paying citizens of developed economies stand by as the BSDs of leveraged, market-based finance push the global economy closer to the point of no return?
After the BoE “pivoted” to emergency QE last week to save highly leveraged, derivative-exposed UK pension funds, I opined along the lines of, “Yeah, okay, sure, the CBankers had no choice in this circumstance. But in the future we need to know who is being bailed out, and why.”
In his latest, economic historian Adam Tooze states it more eloquently:
“Talk of markets at that point become euphemistic and we must ask, beyond the need for ‘systemic stability,’ who are the principal and immediate beneficiaries of these interventions? Who exactly is being bailed out when the Bank of England steps in? The answer is not clear cut. Is it pension policy holders? The economy at large that is spared a catastrophic financial crisis? Or is it BlackRock Inc., Legal & General Group Plc, and Schroders Plc who manage LDI funds on behalf of pension clients? The very fact that we cannot give a confident answer to these questions suggests that we are dealing with a system riven with conflicts of interest. And this poses the question of reform. Does it really make sense to perpetuate a system in which disastrous financial risks are built into the profit-driven provision of basic financial products like pensions and mortgages?”
Short answer: No.
Shadowstats.com shows M2 YoY growth as simply flat. They use their M2 to create a “what-if” M3 chart. They ask and answer the question “What if the FED were still publishing M3?” I’m not smart enough to know if this is an instance of “We have our own facts” type of argument.
Will inflation be reigned in at pivot time, or will we end up with stagflation?
H-Man, no pivot for the time being until something on the inflation scorecard goes green. Any news on inflation abating will open the door for a pivot resulting in a falling dollar. The Fed will rush to that open door but it needs some help from inflation. So far the door remains closed.
OPEC talking about cutting back oil production… which will prevent energy costs from going down any further. And SPR releases coming to a screeching halt very soon. Yet any further tightening of US monetary policy risks further illiquidity in credit and currency markets. Meanwhile EU staring into the energy abyss without any hope now that pipeline in Baltic Sea blown up. The shortage of dollars motivating further selling of US Treasuries by other countries forced to protect their own currencies. War and energy crisis are inherently inflationary. Stagflation appears inevitable.
the immediate effect of fed pivot is severe loss of confidence in the (value of) dollar, and eventual debasement of the dollar system, fed simply cant afford that.
So, do we buy gold, cryptos, LME copper warehouse receipts or what?