Risk Assets Fall As Inflation Fails To Resolve Quickly!
By Mitchell Anthony
September 16, 2022
2022 has been a volatile year for financial assets. Stocks, bonds, and real estate have all slid in price considerably as inflation has remained high contray to the forecast of the Federal Reserve last year. Inflation is the primary driver of liquidity that flows into risk assets. During periods of low inflation and accommodative monetary policy liquidity drives risk assets higher. However when inflation becomes unfriendly that causes the Fed to move to remove liquidity from the system and risk assets perform poorly. This is what we are experiencing today.
The consumer price index or CPI rose to 9.1% this year and is still holding at 8.3% or more currently. Month over month data looks a bit better with only a modest increase in inflation over the last three months but overall the data is still awful. As a result interest rates have risen this year and have been volatile with treasury yields now close to 3.8% and mortgage rates over 6%. Almost all risk assets have seen volatility as optimism and pessimism has played out. The fear is about a terrible economic bust that seems unlikely but can’t be discounted entirely until inflation has been subdued.Read more
Rising Inflation Expectations Drive Investors Out Of Risk Assets!By Mitchell Anthony
July 8, 2022
While inflation has been running hot for over 1 ½ years, investors and the central bank have not believed that the inflation was entrenched and hence inflation expectations stayed relatively low until recently. Over the last 3 to 4 months that position has changed significantly and as a result investors hit the sell button in a dramatic manner last quarter. Risk assets of all types had double digit losses in Q2. Stocks, REITs, Treasuries, Corporate Bonds, Junk Bonds, and Commodities all swooned with the worst losses occurring in high PE stocks and real estate investment trusts. Both of these were down 25 to 30% in Q2. MACM’s dynamic growth portfolio lost over 16% despite a double digit cash position. Clearly we have a new hawkish position from the Fed that combined with investors armed with knowledge of how stocks and risk assets perform during periods of high inflation, combined to drive investors out of risk assets and into cash. Even ultrashort term bond funds lost money in Q2!
The Fed’s new resolve to kill inflation all but ensure that a recession will take place this year and maybe into 2023. The uncertainty of what a recession might do to the current themes of consumption in the globe has caused extreme volatility in risk assets. The US economy has been driven by four strong consumption themes for the last several years. These themes include: housing and related durable goods, the buildout of cloud computing infrastructure, consumers desire to convert to electric vehicles, and consumers pent up demand for experiences. The sustainability of these mostly secular growth themes has now been questioned by investors and will continue to be questioned until more visibility is available causing further volatility in risk markets.Read more
Inflation is Obstacle for Stocks and Bonds!
By Mitchell Anthony
June 15, 2022
Money managers, market strategists, and economists generally agree that financial markets are driven by three things. 1.) Expectations for inflation, 2.) Expectations for central bank policy, and 3.) Expectations for economic growth. And in that order! When all three of these economic criteria are friendly money tends to flow heavily toward risk assets (stocks, real estate, and bonds). When even one of these economic criteria becomes unfriendly, than money flow will change direction and move away from risk assets. The reason why these criteria drive financial assets is that when inflation is very low interest rates are also very low and investors are forced to embrace investment in risk assets by the simple fact that low-risk investments return nothing. Conversely when inflation is high interest rates are also high and investors are more likely to allocate their capital toward fixed income investments or short-term cash instruments with high return and little risk. Interest rates have always risen and fallen with inflationary expectations. Inflation has been down for the count for over 30 years and many of us have forgotten about how this relationship works. All we have known is that inflation has been anchored at 2% and this combined with very slow economic growth, and very accommodative monetary policy, has worked to keep interest rates near zero. This in turn caused financial assets to rise in value dramatically over the last 30 years as investors piled into risk assets.
Inflation is no longer anchored at 2% and is currently running at 6-9% depending upon the gauge. This high inflation has come from the pandemic induced Government stimulus that caused demand to be pulled forward and production of raw materials and durable goods to be reduced. Producers of raw materials and durable goods have taken advantage of the pandemic induced production cutbacks to raise prices considerably and keep them high by continuing to restrict and hold back production. There has been strong cohesiveness amongst producers and price wars have not developed to bring down prices and increase production as demand has returned to normal after the pandemic.Read more
Recession Uncertainties Drive Markets back to March Lows!
By Mitchell Anthony
April 29, 2022
Fears of recession have returned to investor’s minds over the last few weeks as inflation data has remained stubbornly high and the already heightened interest-rate environment has taken its toll on demand for housing and autos. The equity markets are now off 13% year to date as measured by the S&P 500 with NASDAQ and secular growth companies nearing a 20% correction or more. This is the same level that markets fell to just after the invasion by Russia into Ukraine and the subsequent problems with food and energy. That sell off ended after calm words from the central bank about the likelihood of a soft landing and their ability to control inflation without a deep recession. While this is still the perspective being offered by Chairman Powell investors can’t help but notice that inflation measures have not rolled over yet despite interest rates of 3% on treasuries and over 5% on mortgages. Chairman Powell is set to speak again next week. Calming words will be well received by the markets.
Are the markets set to break to new lows?
While this is possible it still seems that we will not get a substantial correction from what we have already seen. There is simply nowhere for money to go that leaves the stock market. It will move to cash temporarily as we have done with almost 15% of our portfolio over the last month but those yields are not high enough to keep money there of any size or substance. This has been the case for a very long period of time and Stock investors have enjoyed a very long period of stability in prices and steady growth since the 2009 recession. Interest rates have been near zero for a decade making fixed income a trap for defensive investors. There was volatility in stocks and bonds when interest rates threatened to rise to compete with money in stocks and real estate. However the return on bonds never got high enough to be a real competitor for stock market money. This volatility and associated rise in rates occurred in 2018 after substantial increases in rates by the Fed. It is occurring again now as investors worry about inflation and the 2.7% rates achievable in US treasuries today. Markets will move back to highs as they did previously once inflation is re-anchored and treasury rates return to 1-2% levels associated with the type of consumption that is expected in America.
Recession and/or economic slowdown will be mild
If we get a recession it will be mild but the length is hard to forecast. The US economy has a great foundation with a sound banking system and just-in-time capacity. Unemployment is very low and money is still cheap. There is very little excess capacity in the economy and no visible rot of any sort that would bring the economy to its knees. Markets today are merely discounting the possibility of much higher fixed income rates if inflation fails to subside and the attractions of bonds if rates were to rise from 3% to over 5% on treasuries. The current inflation environment could well drive that rise in rates which is highly unlikely but would be devastating for the equity market. 5% treasury rates would be strong competition for stock market money. This however is not likely as consumer demand is already waning with the current level of rates and inflation seems destined to subside and re-anchor at much lower levels.
The size of the equity market correction we could get now seems to hinge on investor’s expectations for the size and length of the economic slowdown that’s on the horizon. If the slowdown is perceived to be shallow and short no further downside is likely of any magnitude for stocks. If the recession is perceived to be shallow but long, prices may have to fall a bit further to the downside but likely are still close to their lows. If the recession starts to look like it will be deep and long it’s reasonable for another 10 to 20% decline in stock prices to occur.
As stated above growth equities are now testing their March Lows and now we note a break in defensive equity areas such as consumer staples, healthcare, and utilities which are all suddenly off 5 to 10% in just over a week. This is generally a sign of the end of a correction.
Inflation seems set to subside
As inflation continued to push higher over the last few months treasury rates rose from 1 ½% to just under 3%. However this rise in rates has stabilized as visibility of a pause in demand has become somewhat evident. Demand seems poised to fall as softness in housing and autos is beginning to materialize as 5% mortgages and auto loans take their toll on consumption. Inflation has not subsided yet but it appears to be on the immediate horizon. Food and energy prices are still high but have stabilized and demand for services is clearly on the rise both contributing to the high level of prices. Raw materials are still capacity constrained but prices have been stable for several months now. Oil has declined from $130 a barrel to $100 a barrel. This will show up in gas prices soon. However, headline
inflation prints may remain high as food and energy prices remain well above prior
year levels.
Recession seems almost undoubtedly to be on the horizon. This is defined by two consecutive quarters of negative growth in GDP. First quarters GDP was -1.5% and while the second quarter is forecast to be positive that could well slip negative as consumption continues to wane despite record low levels of unemployment and trends in retail sales to all time high levels. The depth and length of this recession is clearly up for debate. How much overcapacity needs to be trimmed from corporate America as consumption eases? Mortgage originators are already announcing some layoffs but employment in the sector was never even close to record levels and hence layoffs will likely be mild to moderate in size. There is lots of uncertainty about what other industries in corporate America are fat with overcapacity. After careful analysis is difficult to find the fat if it exists? E-commerce giants like Amazon added more capacity recently than was needed for the near term but will likely stick with this capacity and avoid any layoffs and the associated costs of bringing those people back after a brief pause in demand. The auto and housing industries would typically be areas you would look to for rot and overcapacity however both of these areas have struggled to get capacity even close to existing demand let alone have excess capacity. It would seem that capacity will finally meet demand in those areas and inflation will subside or turn into outright deflation over the next year.
Economic and Market Outlook
Equities appear to have already priced in a long but mild recession that re-anchors inflation back under 3% within 1 year. Inflation is peaking now and will likely rollover as recession and the related decline in demand unfolds this quarter. Equities are positioned for a substantial rally as softer inflation data and consumption data arrive. Equity markets may tilt a bit lower as consumer demand ebbs and flows over next month but will ultimately turn higher.
Fixed income areas of the market are still not high enough in yield to draw money out of equities. This could change soon if rates have another jump higher but it is still not the case. Fixed income has performed poorly as rates rose and are still not an option for defensive investors, particularly if rates rise further.
As inflation subsides, the Fed will nurture the economy forward and help it avoid deep recession as inflation ebbs lower and his hands free up for policy action.
Stocks are still the most attractive asset class!
We remain optimistic but ready to adapt and change if needed!
Fed Handcuffed after 30 Years of Freewheeling Use of Printing Press
April 12, 2022
By Mitchell Anthony.
The Most Significant Economic Event of the Quarter was not the War
While most of us thought the most significant economic event thus far in 2022 was the impact of the war in Ukraine on consumer confidence. However inflation really remains the most significant economic problem in the world today and its impact that it has on central bank’s ability to monetize our way out of economic problems. The war has only aggravated this problem with food and energy prices still rising.
The Federal Reserve has had freewheeling use of its printing press for over 30 years enabled by inflationary expectations that were anchored at 2 to 2 ½%. Every single recession encountered since 1990 was easily resolved with the Fed’s ability to pour new credit into the markets and monetize our way out of virtually every economic problem we encountered over the last 30 years. With the dollar being the reserve currency of the world combined with ultra low inflationary expectations the Fed acted without hesitation to print money and run its press as often as needed. Unfortunately America has encountered what appears to be a very difficult inflationary environment that may take several years to resolve with tight monetary policy. This is contrary to the belief that was embraced by central bankers around the world in 2021 as the economy emerged from the pandemic lows. Capacity was largely the driver of inflation in the beginning as producers shut down during the pandemic and were very slow to return their factories and facilities to full-scale. At the same time demand ramped up considerably for durable goods and housing as consumer spent a tremendous amount of time at home instead of traveling. Read more
Will The War End this Economic and Market Cycle Suddenly ? 15% Equity Market Correction Takes A Bite Out of Investor Wealth and Confidence!
March 9, 2022
By Mitchell Anthony
WILL THE WAR END THE ASSET BUBBLE, ENTRENCHED INFLATION, AND THE RECKLESS CONSUMER?
This economic cycle has been wrought with problems. At the top of the list are consumption and consumer confidence issues which have been dealt with through easy monetary policy and fiscal stimulus. However the solutions had collateral damage and we now have entrenched inflation, a consumer that spends with unbridled optimism, and asset bubbles in real estate and financial assets. Now to add insult to injury we have a wild man at the helm of a nuclear enabled superpower that is acting reckless and has declared war on the Ukraine. Historically war has destroyed consumer confidence and pushed the economy into recession quickly. However this war is like none other and the world has to fight Mr. Putin with economic warfare rather than military warfare. This has only exacerbated our problem with inflation because it has been rooted in capacity problems for raw materials of all types and now we add to it things produced by Russia and the Ukraine like oil, natural gas, and some agriculture like wheat. This war will undoubtedly effect consumer confidence along with the higher price of gasoline and soften the demand side of inflation. However the US consumer is not entirely rational and the central bank and Congress left the punch bowl out far too long and the US consumer is addicted to free money and has bankrolled much of it for continued use and spends recklessly as a result. Hopefully a more sober price conscious consumer will emerge?Read more
Russian Aggression Risks Global Recession
By Mitchell Anthony
February 14, 2022
Russia is seeking concessions from the Western world that will enable them to expand their socialistic culture onto previous members of the Soviet Alliance. Russia has not been successful in the democratic world that many members of the Soviet Union embraced after the 1991 breakup of the USSR. As a result they have returned to a more authoritative form of socialism. As such they have aggressively tried to re-annex former USSR Members including Georgia and the Crimea. Their next target is the Ukraine who has resisted and has sought refuge from NATO and the Western World. The Ukraine was promised entrance into NATO in 2014 after the takeover/annexation of Crimea by Russia. This promise has not been delivered as it seems that it would lead to an invasion of the Ukraine by Russia. There is a tug-of-war going on between Russia and the western world. Russia would like to see socialism return similar to the Cold War era that existed in the 80s. America and the West conversely want to see these former Soviet republics become stable productive economies with democracies running their governments. Read more
Are Stocks and Real Estate Poised for a Bust
January 25, 2022
By Mitchell Anthony
The equity market has been going through an extreme period of volatility over the last few months as investors fret about whether a soft landing or a recession is on the horizon. This volatility has everyone nervous because of substantial amounts of wealth that Americans have in our financial markets. If there is a meaningful recession then markets undoubtedly will correct 20% or more from past highs. Conversely if there is a soft landing for the problems that we are having with inflation and growth than the markets will get back on a path to higher prices as soon as this becomes visible. The market is clearly worried about inflation and much higher interest rates and as a result equity prices have already fallen 10 to 15% on equities and demand for homes has softened. This equity correction seems overdone and it would seem that prices will stabilize very soon as we await more data on inflation. We have never had a lasting substantial correction of more than 10% in equity markets that wasn’t driven by a substantial economic event. We have not yet had an economic event and do not believe one is upon us now, however we do recognize we are close to the amount we are willing to lose from a previous high before making sales to protect our assets. We also recognize that the equity Market has had a substantial move over the last two years (over 50% appreciation see figure 1 &2) that must be considered when identifying a stop loss point for the equity market. We believe that it is not time to panic and sell equities aggressively and move to cash but will do so soon if selling persists.
Read more
Will Inflation Wreck this Economic Recovery?
By Mitchell Anthony
January 7, 2022
2021 was a great year of economic recovery from one of the worst events that ever took hold of the global economy. The pandemic! Unfortunately there was some collateral damage and an inflationary cycle began that is difficult to understand. More importantly expectations for inflation have risen dramatically. Inflationary expectations have been anchored for over a decade at very low levels of 2-3%. However the CPI is currently measuring 6% inflation and the PCE (personal consumption expenditure index) is at 4.7%. These high levels of inflation have not been seen in decades and many believe they will not be sustainable because they have been achieved through strong demand that followed a long period of deprivation. These high levels of inflation has caused corporate leaders, business owners, and consumers to fear and worry that there is nothing ahead but significantly higher prices for the next few years. As a result business leaders are acting in a defensive manner to prepare for this inflation by putting plans in place to raise prices for their products. Likewise workers are demanding more wages to offset the inflation they believe lies on the horizon. This sort of thinking has caused inflationary expectations to become unanchored. As this occurs it becomes challenging to re-anchor expectations for inflation back at low levels that are consistent with healthy economic growth without a recession and/or a sharp correction in asset prices. Read more
Irrational Exuberance in Our Markets
By Mitchell Anthony
November 23, 2021
Alan Greenspan’s infamous speech in 1996 hit the nail on the head when he warned the world about the irrational exuberance that existed in both the US economy and US financial markets. For the most part corporate leaders and investors failed to take heed of the notice until it was too late. The exuberance centered heavily on greedy blind ambition as well as ignorance that drove capital into Internet and tech oriented businesses that had far too optimistic visions for their products and product cycles. Some had no products or services at all that were rational. The exuberance caused these businesses to invest heavily in human capital that they had to divest quickly thereof when the bottom fell out at the end of that dot-com cycle in 2000. The fallout from the tech sector dominoed into other sectors and caused a classic economic bust that led to one of the worst equity market declines on record. Similarly the economic strength from 2002-2007 that preceded the great recession of 2009, saw greedy blind ambition drive over-consumption in the housing market into a state of irrational exuberance that resulted in a massive economic bust that took a decade to put behind us.
Equity Markets and Real Estate Assets have surged dramatically over the past two years, with everything from cryptocurrency to meme stocks exploding in value, causing investors to wonder about the existence of rot in our economy? Could we be on the verge of another bust for the economy and the markets?Read more
