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Where Does the Global Economy Go From Here?


Viking

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So where does the global economy go from here? My macro crystal ball is pretty cloudy these days. We have war in Europe - on a scale not seen since WWII - with little near term visibility on how it will resolve. We have inflation running at the highest levels since the 1970’s and all commodities are spiking in price leading some to predict we are in a new super cycle. We have global central banks just beginning to tighten financial conditions (trying to do something about out-of-control inflation). Consumers are starting to get cranky about ever rising prices. Covid remains a factor - global supply chains are still a mess and China is continuing with its zero covid policy.
 

What is an investor to do? Certainly, the extreme market volatility is creating some juicy short term opportunities. Overall, i am getting more cautious; my usual playbook when things get ugly. So I am back up to 65% cash. Why? Buffetts first rule of investing is don’t lose what you got. Second rule is don’t forget the first rule. If i was younger i wouldn’t be 65% cash. I have enough. Don’t need more. Would not be happy if my portfolio fell 20-30% from here. And i am finding as i age out my ability to stomach volatility is changing (diminishing). Moving to a very high cash weighting (for short periods of time) has been a strategy that has worked very well for me over the past 25 years. At the start of the year i was way overweight oil so my total portfolio is up about 8% (was up 12%) so i am happy to largely lock in my YTD performance and sit in the weeds. I will continue to take advantage of all the volatility. But i am going to try and be a little more patient with big decisions. And wait until i get more clarity on some of the questions i ask below. 

1.) How long does the war in Ukraine last? Can it escalate?

- result is flight to safety trade in the short term.

- how do consumers react, especially in Europe?

2.) What happens to inflation?
- will US inflation increase from 7.9% in 2H?

- how long will inflation remain elevated?

- how do consumers react to $+100 oil? Do they get cautious?

3.) Are we in the early innings of a commodity super cycle?

- how high will oil prices go in 2022? How likely is $150 oil? Will high prices persist?

- at what point does high commodity prices affect consumer behaviour (pull back in spending)?

4.) How aggressive does the Fed get, starting this week?

- does liquidity matter?

- purchases of bonds has just stopped (no longer adding liquidity).

- how many times will the Fed raise rates in 2022 and 2023?
- how aggressive are they with balance sheet run off?

5.) What impacts will covid continue to have on the global economy?

- does China continue with zero covid policy?
- how abrupt with consumer shift from goods to services be?

6.) Have we seen peak globalization? 
- will countries look to have more domestic production of critical inputs/goods? If so, is the inflationary?

- if the war in Ukraine persists will it put a chill on relations between West and China: will we see start of economic decoupling here?
7.) How does all these different factors fold into financial markets for the next 3-6 months? Next 12-18 months?

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The more questions you try to answer the more you increase your odds of being wrong. The bigger the questions, the more you’ll inevitably miss.
 

So for me I just try to look at all that stuff, probably a bit more, find a few areas where you can handicap things a little more precisely, and then hang out in those spaces. 

 

For instance each NYSE stock can be bought or sold. Each typically has sets of options that can be bought or sold. Even within the options, there’s dozens of different strikes and prices on said strikes. So for each individual name there’s maybe hundreds of different approaches you can take to making a buck. Now think there’s thousands of names. And thousands of offsets such as commodities or bonds or whatever. All you gotta do is find a few that work for you and you can do well. The traditional approach of “is XYZ a good investment” is so overrated. Or, “what is the market going to do”.. choppy markets are great because of volatility. If you know how to monetize volatility it’s even better. 
 

So I in short, think but don’t overthink. The great thing we’ve been seeing over the last year or so is the decoupling of assets to market correlation. ARKK vs SPY vs BRK TTM is a great highlight of this.

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Unfortunately, with inflation at 8% you are losing purchasing power  even if you don’t lose money. I have some gold (a few percent as Cash substitute) , but I think my allocation may be way too small. Gold may or may not work out well, but just cash won’t do well either if we get a 70’s style scenario.

 

I am in my mid fifties and don’t like the prospect of large losses either, so am am staying very diversified. I do this because reducing risk is more important than maximizing gains. I don’t think that staying in cash is the answer though.

Edited by Spekulatius
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Over the decades, each time the Fed embarks on a loosening cycle, it reaches lower highs and lower lows.

 

At zero, they need to go to QE.  Each time they do QE it gets bigger.

 

The housing market is ludicrous, with people resorting to buying sight unseen (in the ~$600k range, northern VA).

 

The wealth gap is massive — and understandably so with the Fed buying financial assets.

 

Now we have 7 pct inflation and we are still at zero pct rates.

 

Will the Fed raise rates and risk blowing up financial assets and housing?  I doubt it.

 

Does the world really want to use SWIFT and USD knowing that the US will seize your accounts if you don’t use heel to US ideals? I doubt it.

 

How is US going to address the wealth gap?  Probably the USG will give handouts paid for by debt which is supplied by Fed monetization.

 

… I have no idea what I’m talking about.  The only explanation I’ve heard that makes sense to me is from Ray Dalio.  I’d love to hear a logical rebuttal or alternate interpretation of the current state.

 

 

Edited by crs223
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3 hours ago, Spekulatius said:

Unfortunately, with inflation at 8% you are losing purchasing power  even if you don’t lose money. I have some gold (a few percent as Cash substitute) , but I think my allocation may be way too small. Gold may or may not work out well, but just cash won’t do well either if we get a 70’s style scenario.

 

I am in my mid fifties and don’t like the prospect of large losses either, so am am staying very diversified. I do this because reducing risk is more important than maximizing gains. I don’t think that staying in cash is the answer though.


i will not stay in cash so i am not too worried about the hit from inflation in the short term. And living in Canada if commodities rock (as they are today) i do expect the Can $ will start to strengthen at some point (most of my cash is in C$) so perhaps this positioning will help. My guess is i will get a few great opportunities to buy stuff i understand/like during 2022; just don’t know when. As i have said before… @Gregmal  will be my Jiminy Cricket sitting on my shoulder whispering into my ear (so i do not remain too cautious).
 

What i am really trying to understand is if we are at an inflection point. With inflation. With interest rates. With commodities. Etc. Interesting times indeed!

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Hat tip to @crs223 for posting the Dalio video, I think it is worth a watch.

 

@Viking I think you are correct in saying your macro ball is pretty cloudy. We are in a very uncertain environment with respect to the future path of interest rates (another way to look at it is the future path of where the Fed wants asset prices). Fed clearly behind the curve, economy at full employment, inflation at 8%, and likely Republican sweep of government coming by 2024 (remember what happened with long rates in 2016...they skyrocketed after Trump's victory).

 

It is hard to say exactly where the market will go. However given market direction is a combination of fundamentals + positioning, I will offer the following two thoughts.

 

i) The entire financial system is positioned for rates to go up but stay at historically low levels (market pricing overnight rate to go up to just north of 2%). A particularly egregious example of this positioning is in Canadian real estate where prices have become mind boggling on the back of variable rate mortgage rates of ~1%. I saw a tweet the other day of mortgage rates in 2006, where TD's 5yr fixed was ~7%. As a long-term investor, given the current macro environment you cannot rule out the possibility the regime has shifted and we are go back to more 'normal' levels of rates (fun fact if they made the overnight rate 7% today real rates would still be negative), and I think one's portfolio should be insulated against this possibility. 

 

ii) Many individuals such as Russell Napier have argued that because government debt loads are so high we are about to enter into an era of financial repression where rates are kept below inflation. While this is completely possible, what is different today is central banks are far more independent from governments than they were in past eras of financial repression, and hence more likely to push back against high inflation.

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I think that we are not so much at an inflection point , more like an acceleration of trends. Technology trends have allowed autocratic governments to control their populations better and easier.The trend

of less workers will continue and is similar to the clean energy trend..it will take many years for technology to catch up with labor shortages. I admire all the nimble and thoughtful investors \traders

on this board....I think that is what its going to take for capital preservation\ growth in the future.( rather than passive investing\indexing). Kotok made some interesting obeservations on visiting china nowadays.

 

https://ritholtz.com/2022/03/transcript-david-kotok/

https://usmarkettoday.com/will-inflation-stay-high-for-decades-one-influential-economist-says-yes/

https://warontherocks.com/2022/03/is-the-west-laissez-faire-about-economic-warfare/

 

This is just human nature:

It is likely that the expanded use of sanctions will spur countries to pursue models of economic development that increase friction for the global economy. These moves might be conspicuous, such as when countries pursue policies ranging from protectionism to autarky. But they could also be more subtle. China is an outlier in the global economy because its embrace of markets was circumscribed. Chinese policymakers realized that to win their own economic war — the battle for development — the iron fist needed to guide the invisible hand. Other states may come to that same conclusion, particularly if China fares better than more marketized economies at weathering the coming storm.

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The western economies are looking very weak right now and I am concerned.  Our governments and businesses don't think long term and we are in a bad spot and liable to get squeezed.

 

Look at the sanctions against Russia.  Have we ever do e sanctions on this scale before? It seems the west has this in their playbook but that's all it is , a set of strategies.  Nobody has tested this at an economy of Russia's size.  Could there not be blowback.   Not that I disagree with hurting Russia but we have to think it through.

 

I am not sure that paying 1/3 more for gas is hurting Putin.  Feels like a huge wealth transfer and not sure I like to whom.  If one of the goals is to move to more local production of goods this will go against us, as  energy prices are a big factor as is labor.  If China can pick up Russia oil at a discount , then they have that much more advantage in production.

 

We have , as we all know, a great deal of debt in our society. Further we are chained down by social program spending so difficult for the government to ever get out of that.  The whole thing is a farce but its backed directly or indirectly by the USD as a reserve currency.   We just block a huge economy from transacting in USD.  Nothing genius here but won't Russia just sell to China in Yuan.  Once that gets established, who knows where it goes.  Iran and Venezuela of course but maybe India and Brazil move to some Yuan backed transactions too.  If we trigger inflation in our economy and China can mitigate by buying cheap Russia commodities they may look better and better.  

 

For investing, I am still in stocks , mainly US and Canada but I don't like it one bit.  Will be shifting some assets to farmland if I can find a deal.  Also just buying as much stuff as I can. If I think I will need it in the next year or so, I'm buying it.  

Edited by no_free_lunch
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I think it's clear we're heading toward a recession. We're already seeing the yield curve getting close to inverting at certain spreads. Spike in price of every commodity imaginable. Fed signaling they are starting to raise rates. What happens when the tide goes out? I have no idea. But I don't think it will be pretty. 

 

 

 

But in the meantime I'm building out a Wishlist for if/when the panic starts.

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FWIW - no US recession.  

 

1) US economy is ready to boom and will absorb the hits due to commodities. 

2) Russia/Ukraine war will be over in 1-2 weeks -- Russia has already lost, strategically speaking.  

 

You want to be positioned for the rally in equities that is coming and you don't want to be in commodity plays. 

 

Just my 2-cents.

 

Bill

Edited by wabuffo
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Wow - I love this view - I hope you are right!!

 

Think about it - this has been a debacle for Russia.  But as bad as it has been for Russia, it has also been bad for China who quietly was neutral/supportive of Putin.  But China must be getting increasingly alarmed at the 180-degree outcome from what was expected.   Rather than a bolstering of Russia as a strategic rival to the West, Russia is failing militarily, its economy is being destroyed - and even worse, a strengthening of NATO around the US.   But what really hits close to home is the focus this invasion has placed on Taiwan.  If Russia ceases to be a strategic competitor to the US, the world world swings around US leadership to Taiwan.  That's not in China's best interest.

 

So I expect China to make a move to force Putin's hand.  China will join the US and other Western countries to force a negotiated peace in Ukraine before this gets any worse for them (both Russia and China).

 

As for the US economy - just look at real-time employment income (via Fed tax receipts on the US Treasury Daily Statement).  US households have never been in better shape from a balance sheet & income perspective.  They are going to spend now that their consumption is no longer suppressed by pandemic restrictions.

 

Just my 2-cents.


Bill

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Bill,

 

Interesting perspective, as always.

 

With a hot economy (and gold rising recently) how do you see that impacting rates?

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Simply look around you. 

Both the CAD & US economies are coming out of lockdown, employment levels are pretty much what they were pre-Covid, large numbers of office workers being recalled to downtown offices, people are pushing hard to shake off 2 yrs+ of cabin fever, and there is way too much money sloshing about (inflation). Today, the 1M people+ city events are back on across the land, and are as common as water. 2022 is looking pretty good!

 

We have no idea how the Ukraine ultimately turns out. All we know for sure is that the Ukraine will have a very limited harvest this year, and that a great many displaced Ukrainian farmers will very likely take up Canadas offer of relocation - all good for Canadian agriculture and demographics going forward.

 

The long term economic solution remains Putin in a box, same as the 1942-45 solution was the early and successful assassination of Hitler; in the interim, sanctions are likely to remain with us for some time. Higher prices for everything, less hasty interest rate rises to cool the economy, shares prices remaining high as they continue to discount at artificially low rates. 

 

Everybody paying more via higher mortgage interest on variable loans, and higher prices on everything they purchase.

Lots of bitching, because folks either have to lower expectations, buy less, or move to a cheaper location - 'cause the piper always gets paid.

Lots of disruption and uncomfortable change. 

 

SD

 

 

 

 

 

 

 

   

Edited by SharperDingaan
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Calculated Risk is my go to for all things housing and economics. He recently posted on ‘Predicting the next Recession’. Great framework for how to think about the topic and what to watch for. 
 

1.) most common cause of recession? Fed tightening to slow inflation.

2.) “The key will be to watch housing.  Housing is the main transmission mechanism for Fed policy.” 
- “One of my favorite models for business cycle forecasting uses new home sales (also housing starts and residential investment).   I also look at the yield curve, but I've found new home sales is generally more useful.”

3.) “If the Fed tightening cycle will lead to a recession, we should see housing turn down first (new home sales, single family starts, residential investment).  There are other indicators too - such as the yield curve and heavy truck sales - but mostly I'll be watching housing. (I'm not currently on recession watch)”

 

https://www.calculatedriskblog.com/2022/03/predicting-next-recession.html

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On 3/13/2022 at 9:45 AM, wabuffo said:

Wow - I love this view - I hope you are right!!

 

Think about it - this has been a debacle for Russia.  But as bad as it has been for Russia, it has also been bad for China who quietly was neutral/supportive of Putin.  But China must be getting increasingly alarmed at the 180-degree outcome from what was expected.   Rather than a bolstering of Russia as a strategic rival to the West, Russia is failing militarily, its economy is being destroyed - and even worse, a strengthening of NATO around the US.   But what really hits close to home is the focus this invasion has placed on Taiwan.  If Russia ceases to be a strategic competitor to the US, the world world swings around US leadership to Taiwan.  That's not in China's best interest.

 

So I expect China to make a move to force Putin's hand.  China will join the US and other Western countries to force a negotiated peace in Ukraine before this gets any worse for them (both Russia and China).

 

As for the US economy - just look at real-time employment income (via Fed tax receipts on the US Treasury Daily Statement).  US households have never been in better shape from a balance sheet & income perspective.  They are going to spend now that their consumption is no longer suppressed by pandemic restrictions.

 

Just my 2-cents.


Bill

  YTD tax receipts : $1.736T  (March 14)

2021 YTD  tax receipts: $1.42T (March 15)

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On 3/12/2022 at 1:10 PM, Gregmal said:

The more questions you try to answer the more you increase your odds of being wrong. The bigger the questions, the more you’ll inevitably miss.
 

So for me I just try to look at all that stuff, probably a bit more, find a few areas where you can handicap things a little more precisely, and then hang out in those spaces. 

 

For instance each NYSE stock can be bought or sold. Each typically has sets of options that can be bought or sold. Even within the options, there’s dozens of different strikes and prices on said strikes. So for each individual name there’s maybe hundreds of different approaches you can take to making a buck. Now think there’s thousands of names. And thousands of offsets such as commodities or bonds or whatever. All you gotta do is find a few that work for you and you can do well. The traditional approach of “is XYZ a good investment” is so overrated. Or, “what is the market going to do”.. choppy markets are great because of volatility. If you know how to monetize volatility it’s even better. 
 

So I in short, think but don’t overthink. The great thing we’ve been seeing over the last year or so is the decoupling of assets to market correlation. ARKK vs SPY vs BRK TTM is a great highlight of this.

Interesting take and agree completely.

 

What's your take on managing temperament through trading? 

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Depends because nothing is ever static. I don’t trade on feeling or emotion generally, but I also don’t ignore it. You can utilize it to have an edge. People typically behave in similar ways to similar events. There’s an element of predictability to behavior and temperament. So if my initial thought is “wow this is really good” or “oh no this is terrible” I’ve kind of conditioned myself to step back and then look at the opposite end of that reaction. Lean towards to other side of the popular trade. But it’s all highly variable. If your only goal is to make money you eventually realize that being honest with yourself is the only way to achieve that consistently. You typically don’t want to be investing with the crowd. And if you ever get uncomfortable you cut bait immediately because then it’s starting to get in your head.

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On 3/13/2022 at 9:10 AM, wabuffo said:

FWIW - no US recession.  

 

1) US economy is ready to boom and will absorb the hits due to commodities. 

2) Russia/Ukraine war will be over in 1-2 weeks -- Russia has already lost, strategically speaking.  

 

You want to be positioned for the rally in equities that is coming and you don't want to be in commodity plays. 

 

Just my 2-cents.

 

Bill

Amazing how out of all the MSM fact searching and fear mongering…. And “analysis” that took place regarding this Ukraine situation on this site, this short little quip manages to be the most prescient and actionable. Well done wabuffo 

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Yes, extreme volatility has been the name of the game so far in 2022. And my guess is it will continue well into 2022. This will create great opportunities. Economically, the US certainly looks better positioned than Europe.


What did we learn in the past week?

- the war in Ukraine is getting worse.

- the Fed was very hawkish at its March meeting. It is now telegraphing it will be increasing rates 7 times in 2022. Balance sheet run off start will likely be communicated at May meeting (May or June start?). Bond yields popped higher.
- covid in Asia looks like it will rip for a while (more supply chain disruptions).

- sentiment got far too negative on most beaten up stocks/sectors - big rally this past week.

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8 minutes ago, Viking said:

Yes, extreme volatility has been the name of the game so far in 2022. And my guess is it will continue well into 2022. This will create great opportunities. Economically, the US certainly looks better positioned than Europe.


What did we learn in the past week?

- the war in Ukraine is getting worse.

- the Fed was very hawkish at its March meeting. It is now telegraphing it will be increasing rates 7 times in 2022. Balance sheet run off start will likely be communicated at May meeting (May or June start?). Bond yields popped higher.
- covid in Asia looks like it will rip for a while (more supply chain disruptions).

- sentiment got far too negative on most beaten up stocks/sectors - big rally this past week.

The Fed talk may sound hawkish, but when they say they raise the interest rate 7 times and indicate that they don’t go more than 0.25%, we will get to 1.75% at best with inflation around 8%. That’s  really dovish if you think about it.

 

As for COVID-19, I think it’s a nothing burger in Europe and the US, but will be an issue in China foremost because of zero COVID-19 policies and because their own vaccines are crappy.

 

We have seen some insane moves with commodities, US and Chinese tech stocks, I think if you are good at trading those, you can make a lot of money. Mr Market is bipolar and maybe stays this way.

I also think that Mr Market underestimate the chance that the Ukraine conflict escalates. Right now, it looks like a near zero chance of this happening is implied and I would go over this (maybe a 10-20% range).

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1 hour ago, Spekulatius said:

The Fed talk may sound hawkish, but when they say they raise the interest rate 7 times and indicate that they don’t go more than 0.25%, we will get to 1.75% at best with inflation around 8%. That’s  really dovish if you think about it.

 

As for COVID-19, I think it’s a nothing burger in Europe and the US, but will be an issue in China foremost because of zero COVID-19 policies and because their own vaccines are crappy.

 

We have seen some insane moves with commodities, US and Chinese tech stocks, I think if you are good at trading those, you can make a lot of money. Mr Market is bipolar and maybe stays this way.

I also think that Mr Market underestimate the chance that the Ukraine conflict escalates. Right now, it looks like a near zero chance of this happening is implied and I would go over this (maybe a 10-20% range).


Regarding the Fed, it is not often that they take their projections for GDP growth WAY DOWN, and their projections for interest rate increases WAY UP and the stock market rallies like crazy. (I know, that ‘already priced in’ thing.)

 

i am wondering if the start of balance sheet run off provides the next catalyst for interest rates to make their next move higher, especially the long end. When the Fed minutes come out in 2 weeks we will know more (my guess is the minutes will be more hawkish… the Fed is pivoting as fast as they can).

 

i agree the risks to Ukraine escalating appear to be under appreciated by Mr Market. I think escalation would provide a potential ‘victory’ for Putin. Stage a ‘fake’ incident and then milk it for all the propaganda he can (domestically and internationally). Something where Russia is the ‘victim’. This war is FAR from over. 

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In the long term, the big picture is that deglobalization continues, the USD becomes less central etc. Fragmentation.

 

Shorter term, it depends on when the Fed starts QE again and continuation of trends such as reopening, commodities shortages etc.

 

 

 

 

 

 

 

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