As The Tri Polar World Turns: Market Speed
916 words – a 2 minute read.
EXECUTIVE SUMMARY
The speed at which market narratives have changed together with the speed at which markets are discounting those changes helps one understand the cross asset sell off that was the 1st H of 2022.
As we think about the 2ndH we introduce Market Speed: the speed at which financial markets discount new narratives about the future. This new moniker joins: Covid Speed, Climate Speed and Conflict Speed in our speed lexicon.
Market speed is exacerbated by what Columbia Univ. history prof Adam Tooze calls a “polycrisis”, a multi faceted crisis born out of many smaller crises that few understand or can navigate. What the BIS calls “a combination of inflationary and recessionary forces that together with financial stability risks is historically unprecented”.
Such an environment drives investor apathy and illiquidity across assets thus exacerbating price volatility.
In addition to the speed of narrative shifts and market pricing we remain focused on what comes next: inflation, recession, stagflation? We expect inflation to soften & global growth to stabilize as the US slows and China recovers.
Our medium term view of a new, new world of high nominal growth led by a global cap ex boom & surging productivity to cope with the 3Cs of: Covid, Climate & Conflict remains intact. As such so does our Asset Allocation.
CLIMATE
Europe continues to lead the Global climate fight, even as war rages on its borders. Two recent decisions stand out: first the decision to implement a Carbon Border Adjustment Mechanism (CBAM) to both protect its own industries & spur others and second its commitment to phasing out ICE vehicles by 2035.
ECONOMICS
It appears that the Fed may have top ticked inflation concerns with last month’s post meeting press conf. Since then rates have collapsed – as I write the 2 yr. is at 2.8%, the 10 yr. UST at 2.9%, inflation breakevens have done the same – 5 yr. now at 2.6%, down from 3.6% in March.
Forward rates now suggest rate cuts in 2H 2023; markets are pricing in a rate cycle for the Market Speed era – short and sharp. Falling commodity prices – from gasoline (back under $5 at the pump) to food (Bloomberg Ag subindex marked June as worst month in over a decade) provide support.
Risk of a technical recession has grown in the US and Europe but cashed up consumers, corporates & Govts suggest a shallow recession if at all.
From a global growth POV, the sharp recovery in China as highlighted by its best PMIs in a year deserves much more attention than it is getting – is that the next narrative shift to come?
POLITICS
Pres. Xi is the clear winner from the ebbing of China’s Zero Covid lockdowns as both Shanghai & Beijing report zero cases for the 1st time since February.
The US political system on the other hand increasingly appears broken: from the Jan 6th Comm reports of a well developed and planned coup attempt by then Pres. Trump to mass gun violence & a Supreme Court that seems to want to take America back 200 years, it is an ugly mess.
POLICY
A desynchronized policy mix is developing between a tight money & tight fiscal US and a loose monetary and loose fiscal China. Japan is also running loose fiscal & monetary policies. This may be what saves the global economy from recession in the coming quarters.
The ECB will join the Fed in tightening monetary policy this month but EU fiscal policy remains expansive thru the Next Gen program.
Could we see an ebbing of the policy upheaval of the past two years in the coming quarters? Market Speed has sped up the reaction function, potentially shortening the policy process.
MARKETS
Its been a brutal stretch for long only, pubic market investors like ourselves. History, while not serving as a great guide to date, does suggest that after quarters like the one just ended, returns tend to be quite solid. One can hope but hope is not a strategy.
We continue to think we are in a bottoming process for equites with China and the Innovation Space being first in and showing signs of being first out. Sentiment and positioning are favorable, valuation appealing especially outside the US where the policy mix is better.
The failure to hold any equity rally suggests more needs to be done – especially on the inflation front – clear signs of rolling over will most likely be necessary to convince markets the Fed will not tighten into a policy mistake & deep recession.
Earnings will also be very important – much work has been done on shallow vs deep recessions and how earnings react. We remain of the view that a high nominal growth environment should support earnings in the 2H.
We remain deeply UW FI and are taking our risk in US HY where we believe we are getting paid to take limited risk given no refi mountain and very low defaults ex a deep recession.
Our Commodity OW also remains intact – we view the recent selloff as heathy profit taking and see supply constraints and decent demand profile as supportive across the complex.
We have been wrong about the USD but do not see now as the time to chase. Our exit from the Crypto space was a case of better late than never.
Have a relaxing 4th & rest up for what will likely be a fireworks filled 2H!