Fri. Jan 21st, 2022


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Good morning, welcome back and happy new year. We managed to avoid the year-ahead prediction contest because we are at least as bad with predictions as everyone else. But this is the beginning of a new year, so we thought we could at least explain what we think are the most important celebrities and strangers in the market right now – that is, where we think we are, if not where we are going we are not on our way.

Email us: robert.armstrong@ft.com and ethan.wu@ft.com

Where we are when 2022 begins

The celebrities:

  • Monetary conditions will tighten, at least until the market or the economy hits an iceberg; this will put pressure on asset prices. The Federal Reserve is reducing its bond purchases at a faster pace. It looks like it will raise rates in the middle of the year (although his fundamental bet is still it inflation will be transient).

    There are other key determinants of the amount of dollars circulating, as Michael Howell of CrossBorder Capital (our favorite liquidity analyst) points out. There is the Treasury general account – the government’s checking account with the Fed – which is being rebuilt after it was reduced to almost nothing last month. This means the government draws liquidity from the system (by issuing debt) and does not put it back (by spending). Another variable: the Fed is big reverse repo program, according to which he sells short-term debt bonds to withdraw cash from the banking system, in an effort to prevent overnight rates from turning negative. Unplugging it can offset the taper and TGA build-up. Meanwhile, the European Central Bank and China’s central bank are tightening and sticking to neutral, respectively.

    All else being equal, when there is less money around or it is more expensive, asset prices stare against it. People who feel they have too much cash, try to get rid of it and offer the price of other goods.

  • Market prices indicate investor confidence that inflation will decline soon. If you bet on inflation or growth that boils over, fine. But the market do you think you are wrong. Break-even points – measuring the spread between inflation-linked and vanilla five-year bonds – show the market’s thinking. Five-year expected inflation is less than 3 percent:

    That, of course, can change. Maybe that’s changing now; yields have risen over the yield curve over the past few days, and there appears to be a rotation to cyclicals and banks, which also indicates some inflation. And:

  • Supply chains remain tied, and we still do not know when they will return to normal. The New York Fed’s new meter of global supply chain pressure clearly tells the story:

    Some supply restrictions are eased, but most are not. Analyst predictions are desirable. Some expect a cruel 2022 while others think the second half of the year may bring relief. Notably, even optimists do not expect a full return to normal in 2022, but rather a normalization in certain sectors. Do not be fooled by headlines later this year that say supply conditions are getting better. The extent of supply problems matters just as much as their job.

  • The most risky stock assets are already in bear market area. But junk credit spreads remain very strict. The technological long-term ARK Innovation ETF is as good a measure of this as any other. It has fallen by 27 percent since November. But low-quality credit has not skipped a beat. Treasury spreads for CCC-rated securities (Fed data) have been below 7 percent for almost a year (the very low point in the historical range):

    The contrast of equity / debt is not so strange. Creditors are ahead of shareholders in a recovery from bankruptcy. And in any case, there are no bankruptcies at the moment. Credit spreads are still the fear measure to follow in the year ahead.

  • The market is very thin. US stocks, as we have pointed out, was exceptional in both performance and top-heavy. So much so that to hold the S&P 500 last year the average hedge fund almost triples return. Even better if you just kept the top stocks – what we call the S&P 10:

    Globally, the US is responsible for the bulk of equity gains. And only a few stocks account for the bulk of U.S. profits. The lean market does not – as many market commentators have implied – consistently predict a correction. But it’s still spooky, if you ask us.

    Especially since the main reason why the super-duper shares rose is not profit growth, but multiple expansion. There were a few excitement over the past few days, Apple’s value has tripled from its lows during the pandemic to become a $ 3 billion company. But most of the increase is due to a higher price / earnings ratio. Bloomberg data:

    The relationship between individual shares’ valuation and their future performance is also not determinative. All the same – spooky.

The unknowns:

  • How big a deal will Omicron be economically? We like the optimistic approach of Omicron. As offered, e.g. here, it goes as follows. Cases are much higher, but hospitalizations are not. The vast majority of the vaccinated, and many of the unvaccinated, suffer from mild symptoms. The new pill (Paxlovid) should improve the chances for those who do get very sick. So, in the case of the US, we can get to the other side within (say) a few months without widespread disaster and with a large majority of the country either triple or with resistance to being infected, or both. It could eventually take the shackles of the service economy and the labor market – and give asset prices a leg up.

    We can think of a million ways this can not happen. But cards like these, of the FT using UK data, mixing hope with our uncertainty:

  • Can China curb its property crisis? China’s economic growth is slowing as it reluctantly moves away from its investment-driven growth model. But the massive debt and overbuilding that results from that model continues. Can the authorities bubble the air out of the property without a financial crisis? So far, they seem to have. But the game is still on, and the final score is anyone’s guess. It could be the biggest story of ’22, or nothing at all.

  • Will Democrats introduce more stimulus? Some hold on to hope that Joe Biden’s social policy bill, Build Back Better, can finally succeed, despite crucial Senator Joe Manchin’s protest to the contrary. 2022 will be their last chance to pass major legislation ahead of an expected mid-term route.

    If Build Back Better fails, pressure could build for Democrats to implement policies by executive decree, such as mass student debt forgiveness – give domestic balance sheets a boost on the liability side. Forgiveness by decree will certainly be challenged in court, but the many question marks surrounding U.S. policy could flood markets.

  • Is Tina enough? This is the big one. Why should stocks at all times highs, in price and valuation, not worry us? Because there is no alternative: the earnings returns on stocks are still much higher than fixed income returns. There are serious theoretical questions about this argument (should low returns not indicate lower economic growth, so lower future profits and lower share prices today?), But its psychological power and popularity are undeniable. Even if inflation does not drive up interest rates, something else could lift Tina’s cult. A correction would follow. (Armstrong and Wu)

A good read

2022 is an election year. This will matter to markets. Here, from Split Ticket, is a good analysis on the sharpest edge of the Democratic / Republican divide – the divergent voting habits of white Americans with and without college degrees.

FT Asset Management The inside story about the shifts and shakes behind a multi-trillion-dollar industry. Sign in here

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