Not the Nine o'clock News
...nor the View from the Bridge but now something completely different
I was going to write a new instalment of the View from the Bridge to explain the mess we are in despite the markets gung ho reaction to events of the week, but the Credit Strategist has done it for me; I couldn’t put it any better.
I am working up a piece on Central Bank “strategy” - three words not normally conjoined - so stand by your beds😎
Save Yourself
The Credit Strategist Blog
4 NOV 2023
Stocks enjoyed their best weekly performance of the year after hearing what they wanted to hear from the government. First they heard the Fed tell them what they already knew or should have known - the central bank is almost certainly done raising interest rates (though it will keep shrinking its balance sheet by $90 billion/month). Then they were fed another phony monthly jobs number (the 150,000 jobs were inflated by ~400,000 jobs created out of thin air by government statisticians but the headline number looked “just right” and stocks rallied). So rather than facing the reality of (a) higher interest rates for longer and (b) a weakening economy - which is confirmed by numerous other data points - investors decided to bid up already expensive stock prices. And they also tossed aside any fear of non-market risks, some of them existential in nature, that could create serious headwinds for stock prices in the period ahead.
First, investors ignored the significant likelihood of a disruptive government shutdown starting in two weeks as Congress fights about everything possible to fight about while the risk of war spreading beyond Ukraine and Israel is rising, American society is riven by racial divisions, and years of out-of-control borrowing threatens short and long-term economic growth. The new Speaker of the House is a classic “wolf in sheep’s clothing,” far more conservative than his predecessor Kevin McCarthy. As America hurtles toward an unpredictable (other than certain to be ugly) 2024 election, the chaos in Congress continues with serious negative ramifications for America’s standing in the world.
Second, equity investors also ignored more signs of an economic slowdown (don’t be fooled by the 3Q23 GDP print which was inflated by inventory building and not as strong as it looked). The index of Leading Economic Indicators has declined for 18 months in a row (recession odds are now 70%), M2 (the money supply) is plunging and is now negative, there is a corporate and real estate credit crunch, and the equity risk premium has vaporized. Deal making is in a near depression (with some exceptions like huge energy deals which raise all kinds of interesting questions), defaults are rising, and layoffs are coming to the financial sector (SCHW started last week). Right now might not be the best time to be chasing rainbows in the equity markets. A short-term rally will most likely end up in disappointment.
Last week’s bond rally also seems overdone. While Wall Street and the financial media remain filled with talk of coming rate cuts, I continue to believe that the Fed will keep the benchmark rate at or above 5% through 2024. Betting on the Fed doing the right thing is not something on which we should place all of our chips. But Jay Powell appears highly aware of the risks of taking his foot off the pedal too soon after waiting too long to quash the recent outbreak of inflation that many of us (but not him) foresaw. Lowering rates too quickly would bail out too many zombie companies and properties whose debt needs to be purged from the system. Barring a crisis, I think rates will stay roughly where they are through the end of next year (and they should).
Third, investors ignored two other serious and imminent risks: what happens in Congress (where we can only hope for the least bad outcome) and in Israel (same). The war in Israel is having - and will continue to have - a significant impact on American politics where, whether we like it or not, everything is connected. The attempt to tie Israeli aid to cuts in IRS funding is just one example of how legislators keep playing games with matters of life-and-death in order to score political points rather than solve problems. Congress has two weeks to pass a budget or shut things down, not a lot of time. Best case is passage of a stopgap bill filled with untold billions of excess spending. Worst case is pretty much the same. There are no good outcomes in store under our current group of so-called leaders.
Further, the risk of the war in Gaza spreading remains extremely high because a wider war would serve the interests of Russia, China and Iran, failing countries that can only gain in the zero sum game of international politics by hurting the United States and its allies. Other failing countries like Turkey and Venezuela are also taking advantage of Gaza to distract their populaces from their gross economic mismanagement and suppression of human rights. All of these countries face unfixable economic, demographic and political problems that incentivize their leaders to disrupt the global order. That order, however, is what provided global prosperity since the Second World War and is now facing its greatest threat in decades. Investors should consider that as they decide where to allocate their capital.
In an extraordinarily high risk environment, chasing stock returns when short-term Treasuries offer decent riskless returns seems extremely unwise. One of the biggest mistakes investors make is thinking they have to “do something” with their money. Right now they are better off “doing nothing.” Participating in Wall Street’s relative performance game is foolish. Forcing things is a great way to lose money. Buy five percent Treasuries and gold and save yourself.
