Thus I return from a month’s break on my little island in the sun and find myself back in England, nose to the grindstone. Today, Tuesday, and perchance also St. Valentine’s Day, brings us the US CPI release for January and markets are excited to see whether positioning in both stocks and bonds, or either if you prefer, is correct.
The joy of once a year being completely “off-line” is that one – that one in this case being myself – can escape the white noise of daily market activity and take a slightly broader view of the world and review matters from, as the Americans like to say, 20,000 ft. Just to stick a quick pin into what the past month has brought, the Dow is as good as unchanged, the S&P is up by around 3% and the Nasdaq by around 8%. The US 2-year yield is roughly 30bps higher and that of the 10-year note by give or take 15 bps. So equities are on a roll with a bias towards higher risk while the yield curve is signalling no significant change in its assessment of the development in inflationary pressures whilst at the same time its shape is not reining back on the recessionary scenario. And what does that tell us other than that markets continue to struggle to decide what they want to be when they grow up? Not a lot. And that is where a month on a sun lounger reading proper stuff and reflecting on the whichness of the why comes in.
My central read was the most excellent “Bloodlands” by the American historian Timothy Snyder. Without wishing to bore with what I have taken away from this masterful piece of work – there will be plenty of time for that, going forward – let me summarise that it looks at the history of those benighted expanses of Eastern Europe, especially Ukraine, Belarus and Poland and the events which led to the deaths of countless of millions between 1933 and 1945. This dovetailed into my more recent reading of Antony Beevor’s harrowing history of Russia from 1917 to 1923. And at the end, adding into the equation the current war in Ukraine. Whether it is a hostile invasion or a justified reclaiming of historic borders is a matter of opinion, mine of which is a matter of record, but as I have argued many a time, one might agree or disagree with an opinion but an opinion can never be either right or wrong.
At some point during the past few weeks I picked up a piece forwarded to me by an old contact in Berlin, Achim Duebel. Achim is deeply sceptical with respect to the West’s apparently unshakable belief that it is all good while Russia and China are all bad and although I disagree with many of his opinions – neither right nor wrong – only a myopic fool would not take the time to follow up on some of them. Thus it was that he shared a video which highlighted how the West in general and the US in particular have forfeited their position in Africa to the Chinese. Please don’t get me wrong. China has expanded its influence through its Belt and Road Initiative which has all but enslaved large parts of the continent by way of indebtedness from which most countries will never be able to escape. And at this point in time, at least, Beijing looks unlikely to offer the sort of debt relief which the West has from time to time found itself obliged to implement. Currently, however, many parts of the developing world look benignly towards Beijing and in the same vein towards Moscow.
My Cartesian “nuit de feu” occurred when I began to wonder whether we now, the Russian incursion into Ukraine included, are living in extraordinary times or whether the 33 years since the collapse of the Soviet Union and the reversal of the Leninist-Stalinist expansion to the West were in fact the exception and what we are currently experiencing should in fact be treated as the norm.
Did we, the West, fail to invest the fruits of the “peace dividend” in creating a more equitable world and did we instead waste them on funding for ourselves an unsustainable standard of living? Across Europe and to some extent in certain sectors within the United States we are experiencing social and above all public service unrest where governments are facing the dissatisfied with no better argument that “We can’t afford it”. Of course we can’t. We never could.
But the real peace dividend, the sustained disinflation brought on by liberalised post-Cold War trade flows, generally referred to as globalisation, was consumed away with alacrity. It is no secret than in many cases, be that at government or household level, the low interest rate environment which prevailed from the beginning of this century until the end of 2021 was not used to save the money that was not required to service existing debt but as an excuse to borrow even more. I cannot recall how often I heard that toenail curling nonsense that the government must “borrow more money now that it’s so cheap”. When did it all go so wrong that debt became measured solely by the affordability of interest cost and no more by the ability to repay?
The debt to GDP metric is one which armchair economists love. It is, to be fair, a pretty good one to keep an eye on. But it is not comprehensive for it is not until it is added to the household debt to income stats that the true leverage of a nation becomes transparent. Italy and the UK are cases in point. The former carries a staggering national debt to GDP ratio of 119%, yet the indebtedness of households is only at around 65%. The UK, on the other hand, has a manageable public sector debt ratio of 79% although the household figure is an eye-watering 140%. France is in the unenviable position of a public sector debt ratio of 108% and a household debt ratio of 118% and that is the country where the people are in the streets fervently demonstrating against the raising of the state pension age from 60 to 62. Kerching!
And there with bated breath we shall sit at the opening of US markets awaiting the release of the January CPI figure – forecast at 0.4% month over month for an annualised rate of 6.2% – only to buy the living daylights out of risk assets if it happens to surprise to the downside. The image of the orchestra playing on while the Titanic was sinking is rather overworked, as is the one about the Fed being limited to rearranging the deckchairs, but there must be a point at which markets begin to rethink their valuations.
Equity geeks should look at earnings, that’s microeconomics, and bond folks at the macro picture. What we have, however, is equity markets trading macro and, to be frank, they’re not very good at it. There is more to monetary policy and to the governance of money markets than a quick look at monthly inflation numbers or quarterly GDP or the Empire State Manufacturing survey. M2 Money Supply is perhaps one of the most critical measures and it is in its first significant declining trend since the beginning of the century. Again, once must look at both the absolute and the relative changes.
From around US$5trn in the year 2000, M2 consistently expanded up to around US$16trn ahead of the pandemic in early 2020. ZIRP and NIRP saw it leap to US$22trn over the following two years but since January 2022 it has been on the decline. So far it has only dropped by around US$1trn to US$ 21.2trn but it is contracting and a quarter of a century long trend of unbroken monetary expansion has come to an end.
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There are shifting monetary tectonics. I would not wish to belittle the catastrophic earthquake in Syria and Turkey but it was a 7.8 on the logarithmic Richter scale. A few days earlier we experienced off Guadeloupe a quake of 6.2. That is logarithmically a little more than a third of the intensity but the difference was in the depth in which it hit. Our little beach hut rattled, we suffered a split water pipe but that was about it. Had the Syrian-Turkish one struck at the depth of the Caribbean one or the other way around, the results would surely have been very different. Many of the tectonic stresses in the Western socio-economic model are rumbling in the deep and have not yet risen to the surface. Neither politicians nor investors nor voters are not taking the tremors too seriously.
Rather than governments having read the signals at the time of the pandemic lockdowns and having prepared voters for harder times ahead, they revelled in the monetary authorities’ decision to take St Mario’s Oil and to do “whatever it takes” by slashing the cost of borrowing to the bone and beyond. Standards of living in non-producing economies were maintained to an extent to which they too have become not a reward for hard work but an entitlement for having once existed. Low labour market participation rates, record low registered unemployment, yet massive labour market shortages speak volumes for policy errors leading to governments and employers alike both facing a critical affordability conundrum.
Today we are 10 days short of the first anniversary of Vlad the Invader launching his bid to quickly and decisively knock over the Kiev government – I shall continue not to call it Kyiv in the same way as I see no need to refer to München or Firenze or Warszawa or Praha or Athinai – and we cannot but wait and see whether a possible or even probable second and better prepared Russian offensive might lead to a different result and, more to the point, how the West might respond, were that to come to pass. Do the US and its NATO allies even have a Plan B?
Global grain prices are on the rise, supposedly because soft commodity traders are expecting renewed disruption to supply lines as a result of an anticipated move by Vlad and the Russian army. Hydrocarbons are also firmer and were it not for President Biden instructing a release from the strategic reserve has prevented WTI from moving back above US$80.00 pbb.
The Fed has told us in no uncertain terms that rates are not about to do what equity markets want them to do and that early easing merchants would do well to put their happy powder away. JP Morgan’s cross-asset strategists are also on board and have renewed their call that equities are more than fully valued and that bonds are not just for wimps. At this juncture I’d still sooner own US 2 years at 4.50% than 10 years at 3.68% as I fear that greed is still bossing fear and that risk remains generally under-priced.
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