Given the current market movements and those to come, investors must adapt to trade in a kind of twilight dimensionsince lately Wall Street narratives change faster than videos on TikTok.
Here’s why: For Bank of America (BofA) chief investment strategist Michael Hartnett, investors find themselves in the most difficult part of the investment cycle because:
- Monetary tightening (withdrawal of liquidity and raising interest rates) seems to be coming to an end, but monetary easing (lowering interest rates and injecting money) by central banks is far from beginning.
- Inflation is over, but the recession hasn’t started yet.
- China’s economic reopening is beginning, while the United States is haunted by the specter of recession.
Investor conviction remains mired in a huge bear market and the risks to markets are great, Hartnett warns in his weekly Flow Show note.
Thus, in the current scenario, he raises three “heretical thoughts” that we review here:
- Minimal inflation in the first quarter. The annualized quarterly variation of inflation is zero percent, while the markets are optimistic about two increases of more than 25 basis points by the US Federal Reserve (Fed) that are already taken for granted, and 200 basis points from cuts in 18 months. It is precisely this last assumption where the most doubtful and questionable is.
And it is that a very tight labor market, plus a new rise in the prices of raw materials driven by the reopening of China and geopolitical issues in Russia and Ukraine could lead to higher-than-expected inflation that reverses the exaggerated expectations of cuts of 200 basis points.
- “Mission not accomplished”, as central banks confirm a new era of inflation. The expected end of the tightening would come before official interest rates reach restrictive levels in real terms and the hikes end with all economies at full employment/inflation well above target.
Central banks are quietly accepting higher structural inflation, voluntarily or involuntarily, perhaps thinking that low rates help service public debt, that higher inflation helps lower nominal debt, and that inflation cures wealth inequality.
This is something that we at Top Money Report have already warned about: the Fed is more likely – even if it doesn’t admit it publicly – is inclined to tolerate inflation well above its public long-term target of 2 percent.
- The recession in the second quarter of 2023 will mark a bottom in bond yields. The 17 percent drop in US Treasury debt paper in 2022 was the worst since 1788 and there has never been three straight years of losses on US government debt.
In this sense, the last 250 years of history say that US Treasury yields will rise in 2023, but a recession is coming and probably a big one, so another bad year cannot be ruled out. Higher unemployment, combined with a 2 percent personal savings rate, 15 percent growth in credit card debt, credit card rates at 50-year highs, and consumer finance companies increasing their reserves against losses “not good”.
From a cyclical standpoint, Hartnett continues to forecast positive Treasury yields in 2023 and a difficult year for stocks, with a “hard landing” and underappreciated credit event risks.
It also envisions a shift from deflationary to inflationary assets, as happened with Japan in 1990, the dotcom crash in 2000, the US and EU banks in 2007, and the BRICs and resources in 2011.
Finally, he forecasts that tech companies will underperform in the coming years, with the new leadership coming from inflationary assets like commodities and non-US stocks.
It’s time to stay cautious
Hartnett is one of Wall Street’s most prominent and accurate analysts. That is why in this space we follow his point of view, and that of other experts, to make our own analysis and conclusions. In this sense, at Top Money Report we maintain the forecast that 2023 will be an “atypical” year, of a “new normal”.
Looking into the past is often used as a guide to the future, which is a mistake. The past is behind us, and although it leaves us lessons to learn, it also teaches us that there are always changes and that previous results should not be extrapolated forward.
What we mean is that we consider it quite likely that the optimism with which risky assets started this year – especially stocks and cryptocurrencies – will once again fade in the coming months.
We would be witnessing a “dead cat bounce” or a “major bear market rally”, which would be picked up lower when the reality – of an approaching recession, high inflation and higher interest rates than we had central banks are accustomed to – exploded in our faces.
Liquidity is king. So probably the dollar and gold as safe haven assets in crisis, more instruments like commodities and other “inflationary assets”, will continue to be the best place to stay. Keep an eye on it and don’t be fooled by the “siren song” of rising markets.
Editor’s Note: This text belongs to our Opinion section and reflects only the author’s vision, not necessarily the High Level point of view.
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William Beard Master in Economics from the Austrian School; liberal, gold market specialist and editor of investment newsletter Top Money Report