Equity markets: best understood through Looney Tunes

I grew up with the work of Friz Freling and Chuck Jones. Never heard of ‘em? Don’t know what they did? I doubt that. They were part of that ingenious collective of animators at Warner Bros who gave us the much loved characters of Bugs Bunny, Daffy Duck, the Road Runner and of course Wile E Coyote, the latter of whom sprung off Jones’s pen. Wile E Coyote is much in the headlines of late with his habit of running over a cliff edge and keeping on running until he suddenly notices that there is no ground there and he eventually drops through the air, to end up in a little wee puff of dust hitting the bottom of the canyon far below. Mr Coyote is at the current time, when risk asset markets refuse to let themselves be spooked by the elusive recession, a favoured friend of analysts. The coyote’s frantic peddling in thin air has become a ubiquitous – and a little overused – illustration.

I have myself over the years drafted in the unfortunate coyote and his fate as an analogy but wonder whether it might not now be the turn of Bugs Bunny who got his name when Ben ‘Bugs’ Hardaway sketched a rabbit which became Bugs’ bunny and eventually Bugs Bunny. His nemesis is the hapless hunter Elmer Fudd. Think of those who look at and write about Wile E Coyote as the Elmer Fudds vainly tracking equity markets which are as elusive as Bugs Bunny and who keep on popping up coolly remarking “What’s up, Doc?”

It’s certainly not easy. Should we be hoping for a strong economic backdrop, in which case the Fed and its peers will, if not keep their foot on the interest rate accelerator, then at least keep it well away from the brake? Or do we look with irrational optimism to a slowdown in which case that elusive pivot might itself become a tad less elusive? It’s hard to believe that we are already in the month of March and that as we head into its second week, we are only a month away from the first companies reporting Q1 numbers. Equity investors can, I suppose, look with confidence towards quarterly reporting. Inflation is supposedly unacceptably high, although seeing as that the inflation number is nothing other than a measure of prices which in turn translate into earning and profits, shareholders can surely be confident that a bumper earnings season lies ahead. No wonder they are calmly standing there chewing on a carrot and declaring “What’s up Doc?”

Jay Powell gave testimony on Capitol Hill yesterday to the rather expansively named Committee on Banking, Housing and Urban Affairs and will do so again today to the House Financial Services Committee. The Elmer Fudds will be hunting for the bull trap which one investment bank after the other has been pointing towards, and yet the investment community is still showing few signs of wanting to disengage itself from risk and to take advantage of risk-free front end rates wrapped around 5%.

Some years ago, I found myself pursuing a line of argument which was predicated on the observation that the 21st century socio-economic edifice is far too complex to be managed under the auspices of simple left and right politics. In fact, I concluded, democratic government which is largely populated by enthusiastic amateurs is entirely unsuited to running a modern state. That said, and holding with the old adage that democracy is the worst form of government, with exception of all the others, we might just have to tough it out. But what we must not do is to expect it to provide all the answers. It appeared to me that even the politicians had, for a while at least, acknowledged that they had lost control and thus it was that they relinquished power and handed it over to the central banks.

There was much moaning at the time that the fate of the economy had been placed in the hands of, horror of horrors, unelected powers. Decisions taken by the central banks which affected millions of people were being justified by the heads of central banks in endless appearances before parliamentary committees but they were not subject to the sort of scrutiny to which a functioning parliament can subject them. That said, given the quality of some of the questioning by parliamentary committee members, it might be best if they are kept at arms’ length from the action. But are the technocrats who sit in the central banks now also in it beyond their depth?

In an exchange of correspondence between a reader and a leading academic, triggered by one of my recent musings on central banks and a copy of which was shared with, me the following opinion was expressed “…central banks are what I would call a basic assumption group subject to groupthink – everyone comes from similar backgrounds, thinks using the same simplistic (neo-classical economic highly political) theoretical models to deal with the anxiety that in reality the real world is too complex easily to grapple with. Consequently, they impose standard ‘solutions’ even if this makes things worse. They are also highly defensive against any challenges to their orthodoxy and deny any evidence that their often very destructive actions only make things worse.”

Remarkably, or maybe not so, the professor in question referred to former Bank of England Governor Sir Mervyn King and his love of fan charts. Fan charts do exactly what they say they do. Instead of forecasting a specific result, they spread out like a fan, offering a range within which the outcome can be expected. On the assumption that it is better to be more or less right than precisely wrong, fan charts offered the Bank of England a fistful of get-out-of-jail-free cards.

I attended a small lunch party yesterday at which, when the prospect of tightening monetary policy until the economy hit recession was being mooted, one of the table guests remarked “But they can’t to that….especially not now!” Longer term readers will know that from more or less 2012 onwards I had appealed for an end to QE and for a normalisation of monetary policy. With growth rates at above 4% when long term trend growth had been assumed to be 3%, the time had come to remove William McChesney Martin’s legendary punchbowl. And what did they do? They simply decided that 4% was the new trend growth rate and therefore there was no need to cool the economy. There is always a fallacious argument to be made for “….especially not now”.

Commodity prices on the way down…

Moving on, shock horror, the Beijing administration has not kicked the man when he was down but has waited until he was getting up. In the opening session of the 14h National People’s Congress, outgoing prime minister Li presented the much-anticipated 2023 GDP growth target. Analysts – that’s Western ones – had forecast current growth to be at between 5% and 5.5% and had forecast it to grow, with the tail wind of post-lockdown spending and a bit of stimulative help by the powers that be, to 6%. Li wasn’t having any of it and has set the target for this year at 5%. That does not, however, mean that 6% is not the tacit aim.

Li Keqiang’s successor – he has resigned and will step down at the end of the year – has yet to be confirmed although Li Qiang looks to be lined up for the job. Li Keqiang – easy to confuse the two – in his address yesterday explained that it would be wrong to set illusory growth targets. In plain-speak, it’s better to play the pragmatist and then exceed a lower target rather than to set and miss a higher one. I’m sure that not even Beijing can command its economy as it would like to. Geopolitics don’t only affect Europe. But the strongest element in the forecast will be the administration’s expectation for the strength and duration of the post-Covid consumer boom. Some of the strongest indicators are already showing first signs of softening, not least of all commodity prices.

Over the week-end I was treated to a list of 12 month price changes in the commodity complex. Other than sugar, they are all lower and some by a significant amount. The shock of the Russian invasion of Ukraine and the spike in prices for any commodity must be included in one’s thinking so the raw year over year figures can be misleading. The reversion to mean of commodity prices is, in the immortal words of the late Donald Rumsfeld, not a known unknown but a known known. Whenever armed conflict breaks out commodity markets go bonkers although before long, irrespective of what is happening on the field of battle, they eventually calm down again. My guiding experience was the price formation of crude oil when Saddam Hussein invaded Kuwait in 1990. The spike was epic and I well recall exchanging impressions several times a day on the phone with a client – now long retired and living in the Valais in Switzerland but still a reader and frequent correspondent – when we watched it go up by the elevator but then begin to come down again by the escalator. We are now generally experiencing the same phenomenon except that since then China has emerged as a huge force in global markets which adds a completely new dimension to the equation and added to that we have the rippling and multi-layered aftereffects of the pandemic.

The commodity markets are talking to us but, I suspect, in a language which the majority of us don’t understand. And China declaring, contrary to expectations, that it has no intention of pushing growth for growth’s sake will not make it any easier.

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