SAT. 03 DEC, 2022-theGBJournal| One year ago, Federal Reserve chair Powell scrapped the rulebook that international investors had been using for more than a decade. Long-dormant inflation had begun to ramp up as pandemic lockdowns ended, but Powell and other central bankers had been warning investors, businesses, and consumers not to panic for months.
They emphasized that the sudden spike in price rises would only be temporary.
However, on November 30, 2021, Powell acknowledged in public that analysis might have been incorrect. He described the inflationary pressures as “strong” while testifying before Congress.
At that point, the annual rate was 6.8%, significantly higher than the Fed’s target rate of 2%. He suggested that the Fed may need to speed up the end of its stimulative bond purchases. He said “It is appropriate in my view to consider wrapping up the taper of our asset purchases. . . perhaps a few months sooner.”
This statement called the peak of the markets, which had surged ever since central banks supported them with essentially free money when Covid-19 struck. Powell effectively put an end to a period of ultra-cheap money that started after the 2008 financial crisis.
We have highlighted previously three topics which continue to unsettle the financial markets: the first one is the risk of inflation and high interest rates as highlighted above. The second is the zero-covid policies in China and the war in Ukraine. Signs of economic slowdown are many but we may also see some signs of improvement.
Consensus has now been reached that inflation has peaked in the US and possibly in Europe. The Fed policies are working in bringing demand down. The main driver of inflation has been margin expansion at corporate level. These corporate margins may now come down for those companies that do not have pricing power, especially in a slowing or recessionary economy.
Consumption is keeping up due to consumers dipping into their savings and using more credit. Tech companies are shedding staff in excess of 200k which is gradually alleviating worries about a wage price spiral.
The zero-Covid protests that spread across China in recent days have been suppressed for now. Global investors don’t have to worry much about this, unless they have investments in public Chinese companies that serve domestic demand. The outlook for the domestic Chinese economy is grim. The locking down of businesses, residential areas and even entire districts is likely to continue, although full-city shutdowns might be avoided. Unemployment among the young is fueling discontent and unrest.
News of a Chinese developed MRNA vaccine being tested in Indonesia fuels hopes of a gradual opening of the economy after the next important political meeting in March.
The war in Ukraine outside the massive human suffering is keeping energy prices high. This will likely be the case until at least the winter of 2023/24 as Europe struggles to find alternative sources of energy. What follows is a massive wealth transfer from energy importers to energy exporters. Many energy importing countries may find energy-intensive manufacturing no longer competitive, and this will erode their industrial base.
The meltdown of three crypto trading platforms leaves tens of billions of USD stranded and inaccessible. The problem is crypto itself, which is still poorly understood asset that supports little legitimate economic activity. The headline grabbing collapse of some of the crypto-currencies and their trading platforms adds to the pessimistic mood in the financial markets.
However, the fall-out on the economy should be limited and more attention will be focused on traditional asset classes.
Looking at data going back two decades, hopping out of stock markets, and hopping back in just at the right time is hard. Sticking in the S&P 500 all that time would have delivered annualized returns of 9.76% but missing the 10 best days would slash that annualized return to 5.6%.
Missing the 30 best days cuts it to 0.8%. The bet for next year appears to be that stocks will stay subdued at the start of 2023 as the slow-down bites, but then stabilize somewhat and even recover. Bonds are broadly expected to do a better job of balancing out any pain, now that yields of around 5% are starting to look more attractive they could in time provide a thicker buffer against further volatility.
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