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Where were you three years ago? By early April 2020, over 100 countries had instituted severe Covid lockdowns. Since then, time has moved slowly, but global action has been persistently frenetic. In fact, it would be hard to produce a more complete list of shocks: a pandemic, yes, but also war; surging inflation and, now, bank failures. Just when things settle down another crisis seems to emerge, applying defibrillator paddles to a waning world narrative. What could possibly come next?
What is certain is that the financial and economic effects of the pandemic are still with us. Macro trendlines have shifted. But this is a tricky environment. The latest data are a reminder that regime changes don’t advance smoothly or predictably. And jumpy, non-linear events, like banks breaking, can change one’s perception of the investing outlook in an instant.
Meanwhile, there seem to be no limits to the possible interpretations of incoming data right now. Recent jobs numbers in America could easily put investors in the soft-landing camp. Or, investors could point to the recent two-week tumble in U.S. bank lending, the largest decline since 2001, and scream, “Hard landing!” But wait, investors could really run for the hills by flipping through a new report from the IMF – apparently the new prophet of macro doom (look out Zerohedge!) – showing the lowest growth forecasts in more than 30 years. If you torture the statistics long enough, eventually they’ll confess.
The danger should be obvious here: It is easy to mistake noise for signal in volatile markets. That means investors should, more than ever, lean into longer-running and the most durable macro trends. To do that, investors should focus on the pandemic’s lasting legacy: entrenched inflation; ongoing government interventions; and a global economy still out of sync.
Prior to the pandemic, a strong consensus held the view that inflation and growth were permanently low for structural reasons. Poor demographics and productivity would keep growth sluggish, while globalization and digitization would keep inflation muted.
This has all been proved wrong. During the pandemic, the world’s major economies administered the largest double-dose of fiscal and monetary stimulus in history, some $17 trillion (a number that dwarfs the bank bailouts of 2008), lighting an inflationary fire central bankers are now desperately trying to extinguish.
In hindsight, the era of zero-interest rates was an aberration, rather than the start of a longer-running trend (if interest rates at 5,000-year lows didn’t make the point, then negative rates, where investors paid governments for the privilege of lending them money, should have).
Where to next? Recent inflation figures in the U.S. have shown a multi-month pattern of disinflation. Expect this to continue as supply chain pricing moderates and high base effects lower annual numbers. But don’t be fooled: The longer-running battle with inflation is far from over.
The lesson from history is that when prices rise as much as they have over the last year, reverting back to a period of benign sustained inflation takes time. The reason is that inflation is as much a behavioural phenomenon as a quantitative one. Workers realize they have wage bargaining power, while companies realize they have pricing power. All of this becomes entrenched into the public consciousness, creating a vicious cycle of higher and volatile prices – even if pressures moderate intermittently.
The U.S. Treasury ordering the Federal Deposit Insurance Corp. (FDIC) to make good on all banking deposits (including uninsured ones) is another sign that the government rescue reflex is still alive and gaining strength.
After a decade of regulatory reform designed to reduce systemic risks, and with lingering pandemic liquidity still providing a big fiscal cushion, this time was meant to be different. Alas, not. With every new crisis, the solution seems to be the same: another government backstop, more bailouts, and more currency debasement. If anything, the pandemic – given the size and scale of the stimulus – simply normalized these policies.
Where does all this leave investors? Ultimately, it removes deflationary tail risks and skews the range of potential outcomes towards higher inflation and higher asset prices. But over time, these policies lower productivity, economic growth, and living standards. The big beneficiaries of these post-crisis rescues are large, established companies, crowding out creative destruction and diminishing business dynamism.
Capitalism is not supposed to work this way. To be sure, interventions have been different across different nations. Fiscal and monetary policies have remained far more orthodox in developing markets relative to the G7 (unsurprisingly, and in a departure from history, inflation remains less of a problem in emerging markets). By far, America has been the most interventionist. But this shouldn’t be surprising after a decade where the U.S. had among the lowest cost of capital, the largest stock market boom, and raging animal spirits – which led to the largest financial excess and leverage. These excesses are now surfacing and regulators are acting. The longer this persists the less dynamic capitalism becomes.
At the risk of stating the obvious, the current business cycle is not a natural one. Economic shutdowns and re-openings were fully coordinated by government, rather than market forces. But because different nations opened at different times and with different velocity, the world economy remains highly de-synchronized. This is new territory. Ever since globalization gathered pace in the early 2000s, world trade and business cycles had become far more correlated, not less.
Now, the U.S. economy is feeling the impact of higher rates and is likely done its tightening cycle. The Euro area has yet to see inflation peak. And, most contrastingly, China’s economy, after spending 1,016 days closed to the outside world, is just starting to open and work off its deflationary pressures (see “Don’t Look Up” for more on this).
For markets, today’s setup is strange simply because China and the wider Asia Pacific region is at a very different stage of its profit cycle than other major global bourses. With higher interest rates, the West is heading into an earnings slowdown. Yet earnings in China have already contracted by a whopping 30% from a year ago (on par with some of the worst profit recessions since the Asian financial crisis). They will now improve markedly as the economy reaccelerates. This is the sweet spot for any stock market: depressed multiples; earnings set to improve; and the policy environment turning stimulative. For all the debate surrounding recession today, investors should not lose sight that a large chunk of the global economy is now bottoming out. Global divergence will be a dominant theme for 2023 and well into 2024.
The pandemic changed everything, but world markets are still pricing in the trends of the 2010s. Despite sticky inflation, long bonds in the West seem bizarrely wedded to a coming disinflationary ice age. The “everybody gets a trophy” environment in the technology sector is now dead, yet tech stocks, and the associated private credit and equity in that space, continue to be over-loved and over-owned. And the U.S. dollar, while already having started a structural downtrend, remains egregiously overvalued.
Meanwhile, we are getting back to a world where near-term earnings and cash regularly paid to shareholders matter. Winners in this environment will be the value sector, international stocks, and currencies in countries that refused to monetize the Covid crisis. These assets all have one or more of the following: deeply depressed valuations, astonishingly high yields, or steady earnings trends.
Arbitraging all of the above macro mispricing will be the winning strategy for the 2020s.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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Content © 2023 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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