Where Does the Global Economy Go From Here?

[changegonnacome]

On 8/23/2022 at 8:51 AM, thowed said:

Which sounds great, except she forgot to add, 'IF they can afford it'....

 

The UK especially and most of Europe have very strong social safety nets & are extremely wealthy economies......subvention will be provided to those that cant afford higher fuel prices. The key question is whether there will be fuel shortages, that is a different question and the more important one.

 

I'm not saying this will be easy or that household budgets wont carry some of the incremental costs (with the downstream effects on the broader economy) but fiscally European countries can & will write a cheque to 'solve' this problem & when your already wealthy and a few % of your income/wealth can solve 'the problem' you have to ask the question is it a problem at all!

 

 

[Parsad]

With $300B of new liquidity being provided by the student debt relief program, I can't imagine consumer spending not being great through Q3, Q4 and into next year.  

 

If you've piled on a ton of student debt, you probably aren't averse to piling into more debt on your line of credit, HELOC, credit cards or refinanced mortgage. 

 

I can see retail, car sales, travel, etc all doing well for the next year...since you've got to reward yourself for knocking off $10K of student loan debt from your $50K or $100K of student loan debt outstanding!   

 

I would imagine less than 25% will actually use this as an opportunity to get ahead and pay down more debt...the rest will spend an equivalent amount elsewhere.  Cheers!

[gfp]

1 minute ago, Parsad said:

With $300B of new liquidity being provided by the student debt relief program, I can't imagine consumer spending not being great through Q3, Q4 and into next year.  

 

If you've piled on a ton of student debt, you probably aren't averse to piling into more debt on your line of credit, HELOC, credit cards or refinanced mortgage. 

 

I can see retail, car sales, travel, etc all doing well for the next year...since you've got to reward yourself for knocking off $10K of student loan debt from your $50K or $100K of student loan debt outstanding!   

 

I would imagine less than 25% will actually use this as an opportunity to get ahead and pay down more debt...the rest will spend an equivalent amount elsewhere.  Cheers!

 

All that matters to a lot of these people is the monthly payment amount.  For a lot of people the monthly payment will barely change from a $10k reduction to total loan balance.  I don't think it will have a huge effect.

[Spekulatius]

14 hours ago, gfp said:

 

All that matters to a lot of these people is the monthly payment amount.  For a lot of people the monthly payment will barely change from a $10k reduction to total loan balance.  I don't think it will have a huge effect.

I agree with @gfp here. Removing 10k of longer term debt wont have the same effect than giving 10k of cash to the same amount of consumers. There won't be much of an impact on spending.

[Gamecock-YT]

On 8/24/2022 at 7:22 PM, Parsad said:

With $300B of new liquidity being provided by the student debt relief program, I can't imagine consumer spending not being great through Q3, Q4 and into next year.  

 

If you've piled on a ton of student debt, you probably aren't averse to piling into more debt on your line of credit, HELOC, credit cards or refinanced mortgage. 

 

I can see retail, car sales, travel, etc all doing well for the next year...since you've got to reward yourself for knocking off $10K of student loan debt from your $50K or $100K of student loan debt outstanding!   

 

I would imagine less than 25% will actually use this as an opportunity to get ahead and pay down more debt...the rest will spend an equivalent amount elsewhere.  Cheers!

 

That's assuming they hadn't already done that since they haven't had to make a payment for two years. It will be interesting if this moral hazard causes more not to pay their student loans at all, just waiting for the next debt jubilee to take the debt down again.

[Gregmal]

Can you imagine predicating your investments on stuff like this? Hmmm, should I make changes to my portfolio because he is somewhat kinda hawkish but not hawkish hawkish but what if he's more falconish with a hint of hawk or wait! what if he's only regularly hawkish? What is wrong with people?

 

https://www.cnbc.com/2022/08/25/powell-isnt-likely-to-tell-investors-what-they-want-to-hear-friday.html

 

“The difficulty he will have is there’s already quite an expectation that he’s going to be quite hawkish, so he has to be at least quite hawkish for that rally not to happen,” said Page.

 

“The challenge for Powell is going to be the tone he adopts. I think he came across as slightly too dovish, not hawkish enough in July,” said David Page, head of macroeconomic research at AXA Investment Managers. “I think he wants to avoid that now, with markets expecting him to be relatively hawkish. ... It’s a very difficult game. It’s a game of expectations. ... It becomes a fine tune issue.”

[Viking]

When Fed Chair Powell spoke at the last FOMC meeting he came across as swinging to dovish. What did the stock market do? It rallied. Big time.

 

Today we got an update from Powell. He is a hawk again. What are financial markets doing? Selling off aggressively. 
 

It appears to me that the Fed funds rate is going to 4%. Crazy low interest rates juiced asset prices… big time (stocks, bonds and real estate). As rates continue to increase it only makes sense to me that asset prices will… correct. Especially the asset prices that saw the largest increases (Canadian real estate, high PE multiple stocks etc). 

 

Does this mean an investor should be 100% cash? No. It just means making money will be much more difficult moving forward. This has been the case since the Fed started on its tightening campaign. For most people NOT LOSING MONEY will be a very good outcome. Return of capital, not return on capital, will be the new mantra - until inflation is tamed.

—————

Most investors the past decade were monkeys throwing darts - to do exceptionally well all you had to do was be all in on risk assets. And the riskier the strategy the better. How has that been working out so far in 2022? 
 

 

Edited August 26, 2022 by Viking

[changegonnacome]

On 8/26/2022 at 12:23 PM, Viking said:

It appears to me that the Fed funds rate is going to 4%. Crazy low interest rates juiced asset prices… big time (stocks, bonds and real estate). As rates continue to increase it only makes sense to me that asset prices will… correct. Especially the asset prices that saw the largest increases (Canadian real estate, high PE multiple stocks etc). 

 

 

I’ve been saying this for weeks/months. Like Jay-P said inflation is broad based and becoming entrenched….as I’ve told people to do before….go look at the monthly non-farm payrolls from the bureau of labor statistics they are pretty up to date and give a good picture of things pretty much right now….….not a popular thing to say but when ‘the little guy’ is getting annualized pay increases of ~10% its nothing to cheer about…..the ‘little guy’ works in low single digit margin businesses and his pay increases get transmitted directly to the products and services he sells….and you get broad based price inflation.

 

4% Fed Funds might be dovish…..I think it is a cert……..5% is on the table IMO in 2023………of course the larger the correction in asset prices (& negative wealth effects) or weakening in the economy the less the Fed will have to do on nominal rates alone….it’s all reflexive………everybody who rallied asset prices in July/August have effectively forced the Fed to be MORE aggressive on rates than they might have otherwise been if SPY had just stayed down 20%! But nope buy the dip habits die hard….and ironically the Fed has to go higher now. For those with a price target of 4800 on the SPY, IMO you should have a Fed funds rate target at year end of 6% to go along with it….cause that’s effectively what your saying…..assets prices stay high, the higher the Fed funds needs to go on rates to get the economy back to equilibrium.

 

It’s clear to me that Jay Powell, at least, has read the history books on inflation in the 1970’s…….and that to ensure the return of price stability you really have to see the whites of the eyes of it really really turning & then wait and put a mirror under its nose to make sure its dead dead….…..I’ve read a lot about the 70’s in recent weeks and it seems that the big mistake of Volker’s predecessors was their inability to stay the course to really seeing both price stability return AND remain in place……financial tightening really works…....the problem was the Fed in the 70’s was always rushing to loosen financial conditions at the first sign of economic weakness or the first sign of dipping inflation (it’s not popular to keep financial conditions tight!!)……it’s also human nature to engage in wishful thinking believing it might just magically go away…..….Larry Summer's has the best analogy I’ve heard so far for this which is that an economy with self sustaining broad based monetary inflation is like a patient with a viral infection, you go on antibiotics (financial tightening) and you begin to feel better (inflation begins to moderate) but like lots of people who go on a course of antibiotics as soon as they start to feel better, they stop taking them and they never finish the prescribed course……and then the virus returns. This is what happened in the 70’s……until Volker took over and gave the patient his antibiotics and he made them take the whole damn course of pills, even as the patient squealed. It worked.

 

Bob Prince from Bridgewater has some very basic math on this and if you don’t get the implications then I can’t help you, but he’s 100% correct on it:

 

- Nominal spending growth in the USA is ~10%

 

- we can all agree the US is at effectively full employment and therefore operating at its maximum productive capacity of goods and services it can produce (there is no slack in the economy). Right? Therefore aggregate productive capacity increases in goods and services can only come from underlying labor/capital productivity gains.
 

- Productivity growth is abysmal in the US at best it’s 4%….I’ve seen worse estimates like 2-3%.Different measures out there but you get where I’m going.

- 10% nominal spending growth minus 4% at best productivity growth = 6% inflation gap……which is made in America inflation. Too much money, chasing too few goods…Milton Friedmanomics writ large.

 

There are three sources of funds in any economy:

 

(1) Money 

(2) Credit

(3) Income (the other side of this coin is spending) they are the same thing my spending is someone else’s income.

 

So the central bank tightens and contracts the supply of money….this it controls …….which effects & transmits directly to financial assets only…..it prints money, buys bonds, holders of those bonds get cash and they go buy other financial instruments so and so forth….….conversely the Fed sells bonds, gets cash that it then incinerates contracting the money supply.
 

Raising the Fed funds overnight rate is different it transmits to credit markets but slowly (check your savings account has your savings interest rate gone up yet?) which in turn over an even longer time frame transmits to incomes. It takes time for (1) to flow to (2) to flow to (3).

 

As I’ve pointed a zillion times here…..look at credit right now……I can borrow still at 2.95% fixed for 7 years…..but nominal spending/income is potentially growing at 6-10% as we discussed above…..I can easily backstop any daily spending shortfall I might have with credit that can easily be supported by nominal increases in my income..…..why because nominal spending/income is rising at ~10%……the 10yr is at 3%, retail credit can be had at 2.95%, easily at 5%…..how the hell is nominal spending growth of 10% right now going to drop to match the 4% productivity growth and bring us into price equilibrium if debt remains this cheap? It wont and it can’t.
 

Nominal spending growth needs to be brought back from 10% to perhaps 4-5% to at least match productivity growth at 3-4% ……..but bond yields/debt costs need to rise too, to maybe 5% to contract credit creation sufficiently, any lower and people will just substitute falling incomes with incremental credit creation keeping the flywheel going…….they’ll just borrow to spend cause it makes sense to do so which in turn will support spending growth which you won’t get to fall sufficiently to get to equilibrium meaning your inflation won’t go away……..all very circular but ultimately rather simple.

 

Anyway the levers above have to be pulled and they can get pulled in various ratios to get the same effect. Maybe Fed funds doesn’t need to go that high if the stock market drops 50%, while at the same time spending falls off a cliff from negative wealth effects or productivity gains accelerate through smart government investments and we get back to equilibrium & price stability but right now we are a long way from any sort of equilibrium……as I’ve said on other threads……two movies were about to see….…..”Higher for Longer (Lower Multiples)” and its sequel “Earnings Recession”……its kind of what just has to happen from here to get back to 2% inflation. Discount rates go up, credit creation slows, the economy slows & spending decelerates or contracts with corresponding rise in unemployment. End of story.

 

I’m seeing a backbone to Jay in his recent pronouncements and I think he’s been reading the same books I have……he wants to be like Volker, not the shithead spineless technocrats who came before him that nobody remembers today. I was bearish before, but now I’m convinced that this Fed is not gonna do re-run of the 70’s….it’s gonna stay firm in the face of stock market falls & rising unemployment/weakening economy till its sure inflation is dead and buried.

 

Edited August 29, 2022 by changegonnacome

[Dinar]

I would like to make two points: a) there is no way that US has 3-4% annual productivity growth, were are lucky if we have 1% per annum b) the biggest driver of inflation is very loose fiscal policy pursued by the US, not monetary policy. For instance, Biden's 30% increase in food stamps in 2021, two stimulus bills by Trump, the 2nd one absolutely unnecessary, Biden's third round of stimulus and now his build back better bill recently passed.  There is not much monetary policy can do when gov't gives out 10% of GDP over two years in additional welfare/fiscal subsidies/etc...  We will not get inflation under control until Federal government stops acting like a drunken sailor on leave.

[scorpioncapital]

I don't understand how hammering the stock market reduces inflation. Do people actually spend a ton of their capital if the stock goes up a few percent short-term or even medium term? Or do people invest for many years, for retirement? Are the aggregate withdrawals when the market goes up the cause of significant inflation?

[Gregmal]

31 minutes ago, scorpioncapital said:

I don't understand how hammering the stock market reduces inflation. Do people actually spend a ton of their capital if the stock goes up a few percent short-term or even medium term? Or do people invest for many years, for retirement? Are the aggregate withdrawals when the market goes up the cause of significant inflation?

Its loosely relevant but not that much. 2022 has become the year where folks have convinced the world that anything positive occurring in the economy or world is actually bad LOL. 

 

That and too much of the market is only basically interested in trading whats gonna be said next week or month. 

[Gregmal]

What you heard from Powell on Friday was basically what some folks refer to as the Fed call. Basically, for the time being, its in his interest to keep things subdued. So we got a bit of a rally; IMO largely caused by folks seeing the peak is already in with inflation and that the world doesnt end with a 3-4% Fed funds rate. You had book marking into Q2 end as well which exacerbated the selloff...but largely, I think Powell wants to keep people from getting too aggressive. Otherwise literally nothing has changed and if you were enlightened by anything Powell said then obviously one is not doing their own work because it was nothing new, just different adjectives and sequencing, probably for effect. 

[Spekulatius]

Ignore Powell. Just watch what the ^TNX and the ^TYX is doing.

 

I am not claiming that they can't give wrong signals, but at least there is money and a market behind both of them. Powell's talks come with an agenda.

[changegonnacome]

1 hour ago, scorpioncapital said:

I don't understand how hammering the stock market reduces inflation. Do people actually spend a ton of their capital if the stock goes up a few percent short-term or even medium term? Or do people invest for many years, for retirement? Are the aggregate withdrawals when the market goes up the cause of significant inflation?

Yeah it matters - wealth effects and money multipliers means it’s bigger than you might think. Don’t think narrowly in terms of withdrawals, there are never really withdrawals…it’s confidence & optimism that drive purchasing decisions. 
 

Don’t forget also that the value of the stock market and the multiple placed on earnings is really a cost of capital assigned to each company….companies make investment decisions relative to their cost of capital…all things equal lower cost of capital they make more investments & well the opposite. So your question should be do companies invest less in P&E with lower multiples….well just ask the O&G guys….then ask is business investment a relatively important spending line item in the American economy.

 

Finally its just not the stock market valuations Powell et al is after it’s the net present value of anything with a cash flow.
 

If you aren’t thinking about a world where the 10yr T yields 4-5% and what implications that has for your portfolio positions I don’t think your doing yourself any favors. 

[Spekulatius]

My simple mental model is that the cash flows  from the stock market is discounted by roughly 8% (5% equity premium +3% risk free rate) right now.

 

So if we go from 5% risk premium to 4% risk free rate, than the same cash flows are going to be discounted by 9%.

 

8%/9% = 0.89 or -11% which is the expected change in valuation due to a durable risk free rate movement.

 

Now in reality future cash flows could sink (due to the economy growing less at higher rates) and also the equity risk premium tends to go up when the economy goes into a slow growth or a recession, but those numbers are a good framework how to think about the impact of interest rate rises on stock valuations.

 

Aswath Damodaran talks about this and actually mentioned a higher rate for the stock market valuation adjustment - I think it watch 15-20% rather than 11%. I don't know why and he likely talks about his reasoning somewhere and I have missed it.

 

 

[changegonnacome]

26 minutes ago, Spekulatius said:

Ignore Powell. Just watch what the ^TNX and the ^TYX is doing.

I’d usually agree but think of the people on the bond desks driving the bus on the TNX & TYX right now……what’s the average age?…..these folks haven’t seen 6%+ inflation before and a Fed fighting broad based entrenched inflation with rate rises & QT….it’s never happened in their adult lives and certainly never in their professional career.
 

I’m not surprised those markets are muted, nobody has the playbook and if there is one it has dust on it and they’re looking for it right now.

[changegonnacome]

3 minutes ago, Spekulatius said:

My simple mental model is that the cash flows  from the stock market is discounted by roughly 8% (5% equity premium +3% risk free rate) right now.

 

So if we go from 5% risk premium to 4% risk free rate, than the same cash flows are going to be discounted by 9%.

 

8%/9% = 0.89 or -11% which is the expected change in valuation due to a durable risk free rate movement.

 

Now in reality future cash flows could sink (due to the economy growing less at higher rates) and also the equity risk premium tends to go up when the economy goes into a slow growth or a recession, but those numbers are a good framework how to think about the impact of interest rate rises on stock valuations.

 

Aswath Damodaran talks about this and actually mentioned a higher rate for the stock market valuation adjustment - I think it watch 15-20% rather than 11%. I don't know why and he likely talks about his reasoning somewhere and I have missed it.

 

 

Broadly in line with my model & a good explainer why longer duration assets are so sensitive to higher rates. Higher risk free rates just crush the NPV of earnings that are 10-15 years out in the future.

 

Discount rates IMO have more to go just based on the rising risk free rate but you’ve touched on the second shoe to drop which is earnings.
 

The Fed is engineering a slow down in both money growth and credit creation and spending, it’s inevitable and actually required (to fight inflation) to bring nominal spending levels down which will affect SPY earnings relative to their 2021 peak….now add rising cost pressure at a firm level via wage demands and the strong dollars effects on SPY earnings plus underlying weakening in the Euro area & China and really I’m not too sure what the bull case is for SPY earnings growth heading into 2023? If you’ve seen it I’d love to read it.

 

Which is why it’s the second shoe to drop on index valuations.

[wabuffo]

 

1 yr inflation expectations falls below 2.3%.   The Prices Paid component of all 5 regional Fed surveys declined in August, and all but one (Richmond) is at its lowest level since at least January 2021.

 

I agree with Spek - the Fed's rates (IOER, o/n RRP) are meaningless.   What's important is the yield on 10-yr & 30-yr Treasury securities.

 

30-year fixed rate mortgages are based on the 10-year Tsy rate and it has flattened out.  Meanwhile the historical spread between 10-yr Tsy & 30-yr mortgage has blown out well above its historical 170bp spread & mortgage rates have begun to fall.  Equity risk premiums for DCFs are priced off of the 30-year Treasury yield & it too has stopped rising.

 

Meanwhile high-yield credit spreads have collapsed and losses on all sorts of consumer loans are at 30-40 year lows.  Employment income is booming in the US.

 

Can we talk ourselves into an economic contraction.  I don't think so but we sure are trying with all the bear porn.... 

 

FWIW,

Bill

 

[Gregmal]

There’s two sides that need to get evaluated. Too often people arrive at one, then stop. All the time we see “omg recession” type bullshit. Followed by something along the lines of “earnings are going to evaporate”. But the next leg, and it’s just as important, is..what follows? If we have a recession and then a recovery who gives two shits about the dip? Look at the whole pathetic market reaction in real time, to COVID. As tough as Powell and friends talk, they openly admit the goal is to raise and then bring it back down. So of course you have to be sensible with how and where you invest, but really, even if we get 4-6% rates for a few years and then they come back down, so what? Once upon a time those were entirely normal and healthy rates and I am still not unconvinced that this still isn’t the case. God forbid we get back to a point where you actually have to do some work to make money. No more tech companies at 1000x earnings? Good!

[Gregmal]

To be fair, the bear case is pretty good. Everything that is actually good is bad and anything bad is game over. And either way the Fed has to destroy everything in order to insure we solve inflation which has already peaked and few understand anyway….

[changegonnacome]

 

41 minutes ago, wabuffo said:

Meanwhile high-yield credit spreads have collapsed and losses on all sorts of consumer loans are at 30-40 year lows.  Employment income is booming in the US.

 

Of course they are at 30-40yr lows!!!.....nominal incomes against that debt are rising at ~10% annualized and consumer credit is readily & freely available at ~5% in an economy printing 6% CPE.....real inflation adjusted interest rates are easily MINUS 1% right now.........& debt servicing capacity on both existing old fixed rate debt and newly acquired incremental loans are well supported by nominal income/spending growth.........but what you've just described is part of the inflation dilemma the Fed is facing. That mix will not see inflation come down....a shoe needs to drop to bring us back to equilibrium....and there are three sources of funds in an economy - (1) Money (2) Credit (3) Income/Spending....and the extent to which each lever needs to be pulled to get back to ~2% inflation is the trillion dollar question.

Edited August 29, 2022 by changegonnacome

[Gregmal]

The consumer being healthy and credit being available to those with good credit profile isn’t inflation and it’s not a dilemma. Wasn’t the argument that inflation is hurting the consumer? I think the most sinister thing with inflation is that it seems to have unlimited definitions. 

[Gregmal]

It’s like in July when everyone was yelling about inflation and it’s like ok what’s going up? Nothing. So how is there inflation? Oh jobs! Looks like we need widespread unemployment to have things stabilize. Then it’s like wait what? And you start to see how crazy this all is.

 

People with home equity can borrow at 5%. Maybe it’s 3% maybe it’s 6%. Who cares? This has been true for decades. Folks who don’t have assets or good credit aren’t borrowing at 5%, it’s like 25-30%. Maybe 15% or they’re diligent looking. This isn’t inflation. It’s just normal economic activity. 
 

What is good though, is there now seems to be a clear collar on the rates rising hysteria. For a while there was enough babbling about high single digit and low double digit rates that you had to entertain it even though it was clearly preposterous. Now it’s like 5% Fed funds rate for a year. And it’s like so what? People are better off completely ignoring Powell. He says he’s data dependent and he’s also proven to have political motivation. The data and the motivation more or less assure you this is at its end. Maybe you get 50 or 75 points in a few weeks. When it’s all said and done I think we look back on this and marvel at the utter insanity of folks making a big deal about 3-4% treasuries. During GFC they were like 5. 

[changegonnacome]

24 minutes ago, Gregmal said:

The consumer being healthy and credit being available to those with good credit profile isn’t inflation and it’s not a dilemma.

 

Credit, its cheapness and its availability to the consumer such that it supports continued spending growth & therefore inflationary price pressures in an economy at FULL employment & at its productive max capacity is a problem.....damn sure its a problem, its part of the overheating problem and why my favorite ice-cream store can only open Thurs to Sunday now cause they can't get staff!  They literally can't provide me anymore scoops of ice-cream, thank goodness  

 

Nominal spending growing at 10% (supported by rising nominal incomes AND inflation/income growth relative to interest rates), inside of an economy that can only expand its aggregate production of goods & services through 2% productivity gains ALONE because its at FULL employment..........has a problem and that problem is called inflation........too much money, chasing too few goods & services........the classical definition.

 

24 minutes ago, Gregmal said:

Wasn’t the argument that inflation is hurting the consumer? I think the most sinister thing with inflation is that it seems to have unlimited definitions. 

 

It's hurting those on fixed incomes & those who's labor bargaining power see's them unable to 'keep up' such that they're purchasing power is falling in real terms. The rubber really hits the road on this soon.....and it will manifest itself in strikes.

 

I sense you think this inflation thing is some kind of market manipulation hoax concocted by Bill Ackman, Jay Powell and Larry Summers to help to drive their interest rate swaptions portfolios....you might be right......I'll keep an eye out for them on the beach in Martha's Vineyard. I'm sure I'll hear them laughing before I see them  

Edited August 29, 2022 by changegonnacome

[Gregmal]

LOL i dunno it just seems like a lot of these people just desire attention. Ackman won big for you and I with PSTH but you have to admit the guy is an attention whore. I don’t know about every single player involved and their motives but it just seems overdone. If we have to go to 5% FF for a bit to “solve” this there isn’t a single thing im holding that I’d sell. It just seems like the whole thing is a massive circle jerk amongst the 1970s and GFC crowd. Surely the end game isn’t as extreme as either of those situations.