This month, we’re looking ahead at the global macroeconomic situation through a long lens.
Zooming in on the situation across the pond, we can easily see that the UK has plunged into turmoil. Significant policy errors led to a much-needed intervention by the Bank of England to avert a full-blown crisis. Most of Europe, in fact, has landed in a recession, with heating costs that have tripled as winter looms. On the bright side, the US has been sending assistance in the form of compressed tankers of natural gas, each of which can heat a small European city for 3-4 months, and Europe’s gas storage units are at capacity. An added bonus is that the natural gas inventory in the US is building up, which will finally put downward pressure on prices.
Technically speaking, the United States is also in a recession, as our GDP declined in the first half of the year. And as most people expect, this recession correlates to a bear market and an S&P that is down 21.7% so far in 2022. Yet the fundamentals are strong: unemployment rates at historically low levels, corporate profits that continue to rise, with cautious optimism in the C-suite. So far, 74% of companies have exceeded earnings expectations. History also suggests that the stock market can expect to enter a bullish period.
One big factor at play is the massive debt we’ve accumulated over the last two decades. To protect the most fragile among our citizens, we’ll incur increased spending through welfare programs, infrastructure, inflation protection and student loan forgiveness. As corporate profits rise, the rising tax receipts will compensate for some of the spending, though we expect taxes from personal wealth will lag. Can the government service the interest rates on current debt without issuing new debt at higher interest rates?
Like everyone else, we’re watching inflation closely. The Federal Reserve has been aggressively increasing interest rates at the fastest clip in recent memory, yet inflation refuses to budge. In September, the Consumer Price Index (CPI) soared 8.2% compared to the previous year. Core prices (which exclude food and gas) also surged by 6.6%. The Fed’s policies need time to show a measurable impact, while it’s possible that the economy is strong enough to shoulder the burden of higher interest rates for now.
There are a few clouds in our sunny skies, and some potential signs of trouble to keep an eye on:
The US Dollar: It’s been growing to the point where it will negatively impact demand for US exports. Will the Feds intervene to intentionally weaken the mighty Dollar?
Stock and Bond Prices: Rarely do their prices decline at the same time, as they just did. It only happened 2 other times before, in 1931 and 1961, and a revaluation of the currency preceded both years.
Gold: Gold has traditionally been the true inflation hedge – offering refuge when inflation runs rampant. However Gold prices have been on the decline implying something is different this time around.
Housing and Semiconductors: These sectors in particular need to reverse course for the economy to continue to function in a healthy manner. The housing market’s downward spiral continues. New home sales declined 25% month over month; new home listings dropped by 22%; and new home starts fell by 8% in September. Demand for mortgages has fallen to the lowest level in 25 years. It’s an alarming trend that has us concerned.
The semiconductor industry has also been underperforming this year and is down roughly 40%. This industry is a reliable indicator of future growth, and it remains to be seen if it can turn the corner, overcome supply chain issues, and find a way to cope with the strong Dollar.
And, finally, our list of winners and losers as of October 21st (going back 12 months):
Losers – Entertainment (-42%), Automobiles (-27%), Internet Retail (-31%), Semiconductors (-31%), Banks (-28%), Building Products (-28%), Auto components (-43%), Containers and Packaging (-28%), Consumer Durables (-32%), Real Estate -32%, Leisure Products -28%, Textiles, Apparel and Luxury Goods (-45%), and Media (-44%).
We’ve been investing in winners: Construction and Engineering (+16%), Oil, Gas, and Consumables (+52%), Energy equipment and services (+30%), Healthcare +17%, Metals and Mining (-10%).
The energy trade is late in the tooth, and we are watching capacity and demand in Europe and Asia and production across the globe. OPEC countries are playing hard ball, lowering output to push prices even higher in these challenging times. It could be good for the bullish case to continue into 2023, but the situation could change rapidly. Some of those energy companies also pay fat dividends.
We are not yet ready to roll into defensive names within utilities, consumer durables, healthcare, and pharmaceuticals, as we see green shoot opportunities to continue to beat the market. This market is also too strong and resilient to be on the short side.
There you have it, folks. It’s a chaotic global economy. It takes a keen eye to read all the signs and interpret them against a backdrop of economic trends, history, and wildcards. We’re watching all those signals closely and will continue to provide updates as the economy shifts.
