In the weeks and months to come, bad news will be good news. Bad news will mean that the economy is slowing, along with inflationary pressures, and interest rates can then stop rising. It isn’t clear how much bad news is required, but we are at least moving in the right direction, punctuated by spats between politicians and central bankers.
We noted this headline recently:
“Stock market down 23.9%, 10-year Treasury bonds lost 18.1%, 30-year Treasury bonds lost 33.8%.”
You might think that must be referring to the UK. But those are US financial markets. The UK is no worse, and in key respects is better, but for “low risk” government bonds to which we will return in a moment.
In April we said:
“Though the headlines are understandably dominated by horrible events in Ukraine, that is not what is moving the markets.”
In recent months we could have inserted “dominated by UK politics” in place of the Ukraine reference. UK politics does not move the markets in any meaningful way despite the loud proclamations of the UK media.
For example, much was made of the Mini Budget and “the markets”, and how Kwasi Kwarteng had singlehandedly blown up the Gilts (UK government bond) market, and caused the UK defined benefit pension fund industry to be on the verge of insolvency. Well, not quite…
… UK index-linked gilts, one of the most boring (safest?) financial instruments on the planet, had already fallen nearly 50% before the Mini Budget – in fact they had peaked back in November 2021.
As we have said many times, there is a (serious) global financial crisis, one which the BBC for one seem loathe to acknowledge with their parochial and naïve coverage.
No apologies for repeating what we said last time, and so that you can safely discard simplistic and misleading media coverage:
“Even before the pandemic, the financial markets were in a vulnerable state due to the US stock market bubble and investor mania… Interest rates hit 300-year lows around the world, and quantitative easing (QE) was… encouraging ever more speculative behaviour by investors. Central banks have lost the plot… and these pivotal decision-makers typically get it wrong.”
Again, no apologies for repeating… a huge experiment by the world’s central banks over the last decade, including the Bank Of England, combined with neglect by politicians, has created a mountain of very poor quality debt and various investment bubbles, without any lasting benefit to the real economy.
You might recall the analogy we used, that financial markets were like the avalanche-prone snowy slope – we just needed the final snowflake. Though the nature and timing of that snowflake was unknown, the extreme vulnerability was, and remains, very clear.
Turning to the stock market, one UK fund manager, for whom we have the greatest respect, has been exacerbated by falls in the UK market, and stated that “many stocks in the UK are on sale at valuations we have NEVER seen before.”
We certainly sympathise with that sentiment. The problem is that this is based on his experience which, although considerable, does not encompass all possibilities. For example, it doesn’t include the 1970s, a very rare period of stagflation.
There are no easy or painless antidotes to stagflation.
Act on stagnation and you create more inflation. Conversely, acting on inflation triggers recession, not just stagnation. Most central banks, led by the Federal Reserve, are concentrating on beating inflation, as they should. They know that if they do not deal with inflation now, they will have to return to the task later, at much greater cumulative cost to the economy.
To show that inflationary pressures are easing, so that central banks can ease off interest rates, there needs to be sustained evidence of the heat coming out of the economy, which might show up in unemployment rates, bankruptcies, or consumer behaviour. Bad news will be good news, at least from the perspective of the inflation battle.
Economic stats in Europe reveal an industry recession already in place. Consumers everywhere are cutting discretionary spending. Going to the cinema is a great example, where visits across the UK and Europe dropped 59% below pre-pandemic levels in the last 2 months. Early days, but this is positive, if you see what we mean.
We are building a shopping list of opportunities, but are not inclined to pile in.
The necessary adjustment, in economies and markets, has some way to go. In the meantime, the blame game amongst central bankers, regulators, and politicians will continue to build – in the UK and beyond – look out for more of that in the weeks and months ahead,
In the meantime, depending on individual clients’ attitude to risk, cash levels range from 25% to 75%.