markets are adjusting to a stagflationary scenario where weak demand (hindering on the ability to passthrough higher costs) would force companies to absorb higher costs therefore reducing margins and profitability. probably the worst macro environment you could face. it might be short as inflation will decelerate at least because of base effect and / or the FED might be force to be more dovish. at worst we might end up with a scenario where the FED will have to buy equities to avoid further damage. Not pretty and i agree there might be room for further repricing of risk. Wild cards? a quick end to the NPI in China, a solution to the Russia Ukraine war, replace Yellen who screwed up badly.
One of the issues here is that Central Banks can't backstop financial markets as they must preserve credibility on the inflation fight.
Either things have to get worse before they get better, or somehow we get a very sharp slowdown in inflation which allows CBs to take the foot off the gas pedal when it comes to tightening monetary policy.
My working assumption is the FED buys equities in the next 5-10 years. The 50 year experiment is coming to an end and all stops must be pulled. This is has many elements of Japan.
japan has been struggling for 30+ years with generating inflation on top of an aging population that saves too much and with limited immigration. the US case is different, almost opposite. my view is that if risk off keeps mounting at some point the FED will have to do something, maybe partially sterlizing the purchase of assets via reserves. well the point is that they are between a rock and a hard place at the moment.
Nice to see someone else using earnings yield charts rather than price charts as a barometer. I've been championing it for the longest time and not many people get just how powerful of a tool it is in its simplicity.
One nitpick I might have is that macro moves in mysterious ways. I'd prefer not to rely on a trend to serve as directional signalling. My honest take is that anything can happen in macro - so be prepared for anything. Or in Munger's words, "Invert, always invert."
What would you rely on besides a "trend" in this scenario then? Is it even possible to fully rely on something then since the macro moves in such interesting ways?
My honest take? No, macro is unpredictable. It's fun to know but its difficult to draw reliable actionable insight from them - in contrast to say company fundamentals. While I won't fault anyone for trying, much smarter men than me have failed at macro forecasts - since governments change the rules ALL THE TIME.
This is why I love listening to them (its genuinely super interesting), but I don't think I'm smart enough to forecast macro. So maybe I'm the wrong person to ask this question. But in my view, it usually ends up being the equivalent of teenage girls guesstimating what the boy is actually thinking.
I'm starting to feel that the term "market cycle" should be replaced with "government cycle". There is too much govt contribution involved behind every market cycle in modern history for it to be a coincidence.
Thank you. Any news about the medium/long term portfolio ideas ? It would be good to have ideas for the long horizon trades. In the times where 60/40 portfolio is not effective as before. Also your tips about rebalancing the portfolio.
Excellent composition Alf, yield charts are too often discounted as being far too forward looking, but some people like to sip margaritas on the beach, while others like looking at trendlines all day.
Excellent piece Alf. ultimately, however you arrive at the conclusion, I completely agree that be cautious is the right way to behave right now. My fear is a more dramatic repricing as the economy rolls over much more quickly than the fed currently believes possible. in that case, you must be nimble because the Fed will turn dovish in the blink of an eye. be wary all summer is my view
Foreign banks can indeed print $$$ outside the realm and jurisdiction of the $ domestic Central Bank (the Fed). It's an interesting part of the money creation in our system, and maybe I'll write an article about that in the future.
If would be more informative to show moves in units of standard deviation instead of applying different colors which is confusing: some up moves are in red, some in green. Also, did yuan really strengthen as implied by your table? Thanks otherwise - very useful.
Amazing! Thank you for sharing Alf. Putting my confirmation bias aside, I have to say that you had me at volatility adjusted market dashboard...
My global macro trading system is all about mapping a non-lognormal distribution of volatility adjusted prices and outcomes...give me volatility adjustment or give me death!
Great piece thanks a lot. I guess the Equity Risk Premium chart can look very different of the market wakes up to chance that real rates will have to be more negative than people think to not break a system which is overly levered, particularly when you compare to other times in history when inflation was an issue. I tend to think the Fed will have to accept higher inflation and just won’t be able to raise rates sufficiently to break the back of inflation. In that case Equities could be cheap?
If you are right on real rates going deeply negative, at these 12m forward earnings yield equities would look cheap.
Of course if that is due to runaway, out of control inflation with negative real wages and Central Banks losing credibility big times you might wonder whether the higher equity risk premium would be actually justified?
Another great article Alf! Your recent appearance on George Gammon's podcast was one of the best I have seen, super clear and understandable. I think it would be great if you would appear on George Noble's podcast as well.
I just watched an interesting video from some Australian analysts discussing a directive sent to banks there last year directing them to implement systems changes by October 2022 to be able to accommodate negative nominal rates. I shudder to think of what kind of inflationary impact that could have on assets and equities.
markets are adjusting to a stagflationary scenario where weak demand (hindering on the ability to passthrough higher costs) would force companies to absorb higher costs therefore reducing margins and profitability. probably the worst macro environment you could face. it might be short as inflation will decelerate at least because of base effect and / or the FED might be force to be more dovish. at worst we might end up with a scenario where the FED will have to buy equities to avoid further damage. Not pretty and i agree there might be room for further repricing of risk. Wild cards? a quick end to the NPI in China, a solution to the Russia Ukraine war, replace Yellen who screwed up badly.
Yep, I pretty much agree.
One of the issues here is that Central Banks can't backstop financial markets as they must preserve credibility on the inflation fight.
Either things have to get worse before they get better, or somehow we get a very sharp slowdown in inflation which allows CBs to take the foot off the gas pedal when it comes to tightening monetary policy.
My working assumption is the FED buys equities in the next 5-10 years. The 50 year experiment is coming to an end and all stops must be pulled. This is has many elements of Japan.
japan has been struggling for 30+ years with generating inflation on top of an aging population that saves too much and with limited immigration. the US case is different, almost opposite. my view is that if risk off keeps mounting at some point the FED will have to do something, maybe partially sterlizing the purchase of assets via reserves. well the point is that they are between a rock and a hard place at the moment.
Nice to see someone else using earnings yield charts rather than price charts as a barometer. I've been championing it for the longest time and not many people get just how powerful of a tool it is in its simplicity.
One nitpick I might have is that macro moves in mysterious ways. I'd prefer not to rely on a trend to serve as directional signalling. My honest take is that anything can happen in macro - so be prepared for anything. Or in Munger's words, "Invert, always invert."
Thanks for the kind words, Aaron.
I believe asset valuations should be interpreted in a relative and not absolute fashion.
What would you rely on besides a "trend" in this scenario then? Is it even possible to fully rely on something then since the macro moves in such interesting ways?
My honest take? No, macro is unpredictable. It's fun to know but its difficult to draw reliable actionable insight from them - in contrast to say company fundamentals. While I won't fault anyone for trying, much smarter men than me have failed at macro forecasts - since governments change the rules ALL THE TIME.
This is why I love listening to them (its genuinely super interesting), but I don't think I'm smart enough to forecast macro. So maybe I'm the wrong person to ask this question. But in my view, it usually ends up being the equivalent of teenage girls guesstimating what the boy is actually thinking.
This is my take too. The govt has to inflate money or deflate assets. This is a *political* decision, so we can't predict it using fundamentals.
I'm starting to feel that the term "market cycle" should be replaced with "government cycle". There is too much govt contribution involved behind every market cycle in modern history for it to be a coincidence.
Thank you. Any news about the medium/long term portfolio ideas ? It would be good to have ideas for the long horizon trades. In the times where 60/40 portfolio is not effective as before. Also your tips about rebalancing the portfolio.
My next piece will be on risk management both for short-term and long-term portfolios.
Later on, I will also release the ETF-only medium/long term portfolio.
Excellent composition Alf, yield charts are too often discounted as being far too forward looking, but some people like to sip margaritas on the beach, while others like looking at trendlines all day.
:)
Excellent piece Alf. ultimately, however you arrive at the conclusion, I completely agree that be cautious is the right way to behave right now. My fear is a more dramatic repricing as the economy rolls over much more quickly than the fed currently believes possible. in that case, you must be nimble because the Fed will turn dovish in the blink of an eye. be wary all summer is my view
Nimble is the name of the game here Andy, agreed!
Great stuff Alf. Thx to Emil and Jeff for your introduction. Can’t wait to see the dashboard!
Hi Woosley, my pleasure! :)
Thank you, very insightful
Glad you liked it!
Great work thank you for your wisdom 👌👌👌👍👍👍
My pleasure!
what I miss in your valuable considerations is the role of the eurodollar off shore money supply, outside any CB.
Hi Frank!
Foreign banks can indeed print $$$ outside the realm and jurisdiction of the $ domestic Central Bank (the Fed). It's an interesting part of the money creation in our system, and maybe I'll write an article about that in the future.
Awesome read as always Alf. Looking forward to the VAMD intro
Thanks Raphael, coming in my next piece! :)
If would be more informative to show moves in units of standard deviation instead of applying different colors which is confusing: some up moves are in red, some in green. Also, did yuan really strengthen as implied by your table? Thanks otherwise - very useful.
Hi Kirill!
I prefer using % or bps moves for assets, and then color-code based on the intensity (as measured by the # of sigma) of the move.
Green = generally easier financial conditions (bond yields down, credit spreads down, equity up) or simply stuff moving up like FX
Red = tighter financial conditions (or when neutral for FCI, stuff moving down = red)
Amazing! Thank you for sharing Alf. Putting my confirmation bias aside, I have to say that you had me at volatility adjusted market dashboard...
My global macro trading system is all about mapping a non-lognormal distribution of volatility adjusted prices and outcomes...give me volatility adjustment or give me death!
Cheers Alf,
Great minds think alike :)
Great piece thanks a lot. I guess the Equity Risk Premium chart can look very different of the market wakes up to chance that real rates will have to be more negative than people think to not break a system which is overly levered, particularly when you compare to other times in history when inflation was an issue. I tend to think the Fed will have to accept higher inflation and just won’t be able to raise rates sufficiently to break the back of inflation. In that case Equities could be cheap?
Hi Malik!
If you are right on real rates going deeply negative, at these 12m forward earnings yield equities would look cheap.
Of course if that is due to runaway, out of control inflation with negative real wages and Central Banks losing credibility big times you might wonder whether the higher equity risk premium would be actually justified?
Thank you so much Alf!
Cloud you please elaborate on how you compute r*? It seems like your estimate is quite volatile - does that make sense?
Hi Anders! It would require another article solely focused on that, which I will write in the future
Alf it's a real pleasure to read your posts, whether or not I agree in substance they always have an air of genuineness that is very refreshing.
It's so nice when people agree to disagree, Will :)
What matters is that we have constructive discussions that help us grow.
Another great article Alf! Your recent appearance on George Gammon's podcast was one of the best I have seen, super clear and understandable. I think it would be great if you would appear on George Noble's podcast as well.
I just watched an interesting video from some Australian analysts discussing a directive sent to banks there last year directing them to implement systems changes by October 2022 to be able to accommodate negative nominal rates. I shudder to think of what kind of inflationary impact that could have on assets and equities.
Thank you, David!
I will be on Noble's podcast soon :)