So, today I’m going focus on an excellent helicopter view from Vincent Deluard’s, Global Macro Strategist at StoneX. He’s been writing some very challenging pieces in recent months and I think this is one of his best !
His December global macro report is called “How the Perpetual Motion Stock Market Will Break” and is well worth a read – drop me an email if you want a copy.
Deluard artfully pulls together many threads discussed in an alternative universe of strategists, economists and investors who have been worrying that a number of malign forces may be coming together.
I’ve discussed many of these before in this blog – the return of inflation, the end of QE, the rise of populism etc – and in a sense this is the flip side to Roaring Twenties thesis although one could, I would argue, witness both i.e unsettled economies and politics as well as high productivity growth and accelerating technological advance.
My own instinct is that the scenario Deluard articulates is a stretch whereas I think an unambiguously positive Roaring Twenties scenario is marginally more likely. That said I think many of the elements Deluard conjures up are, on their own, highly likely.
OK, so lets walk through the scenario which will spell the end of the Perpetual Motion stock market which has made simple 60/40 portfolio investing a slam dunk.
The key trigger is the end of the virus.
“A widely available vaccine in 2021 would be a game changer as lockdowns have fed massive pentup demand for “real” things.”. The return of inflation will be prompted by the real drivers of inflation, “which are not the size of the central bank balance sheet, but the growth in bank credit and wages. Despite the massive liquidity injections of the Great Financial Crisis, bank credit and wages remained muted in the 2010s. An orgy of lending fed by generous Paycheck Protection Program loan and the $15 minimum wage movement have broken this trend: total bank credit is growing at 10% year-over-year and Florida became the eighth state after California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, New York, and Washington DC to adopt a $15 minimum wage. Conditions are ripe for real inflation for the first time in a decade.”
The chart below I think nicely sums up the monetary picture as the monetary base and central bank balance sheets accelerate. The warning signs are obvious in this chart – inflation is possible !
Central bankers will, of course, play a pivotal role, nevertheless.
“Getting back on track would require letting inflation exceed its normal 2% target by about 5.5% (i.e. 7.5% in annual inflation) for a decade, which would match the average inflation recorded in the 70s”.
Read their lips – the central bankers have clearly said they want more inflation, just not too much.
But Deluard then wheels out the dollar thesis i.e that the dollar bears are finally proved right.
“Dollar bears will likely be even more emboldened if, as I expect, the dollar index breaks its 2018 low of 88 next year, which would make the 2014 support level of 80 a logical target. Calls for an end of the reserve status of the USD are premature given the absence of a credible alternative to the greenback. Also, the dollar can experience large corrections without losing its hegemony over international trade and global capital markets, as was the case in the 70s and the 2002-2008 weak USD cycles….Investors should monitor the rise of digital currencies, which would bypass the U.S.-controlled SWIFT system as a potential paradigm shift. China’s realization that the Yuan cannot seriously challenge the U.S. dollar in the current global monetary order is probably behind the efforts to launch pilot programs for a “e-Yuan”.”
I have my real doubts about the dollar collapse story, despite my own musing about a collapse in the US from political dysfunction. I can easily see more depreciation in the dollar in the coming year and would also see the rise of e-currencies issued by central banks as a powerful portent of huge structural change, but for now, I don’t see the dollar under any mortal threat for at least another decade. This strikes me as the least likely process.
Next up, Deluard suggests we are witnessing leakage from the ‘traditional’ stock markets via the channels of gold and bitcoin. “ The longer this lasts, the greater the incentive for money to leak out of the financial system: bitcoin and gold are bought as “insurance” policies against financial collapse. The fact that these insurance policies also pay a premium will increase their adoption by traditional investors.”.
Again, there is much I can agree on (the importance of gold and the steady rise of digital currencies) but I’m not remotely convinced that bitcoin presents any feasible threat for at least another decade.
Deluard finishes on the obvious political point – that we are about to experience yet another decade of populism. The graphic below from Bank of America nicely sums up the range of policy changes.
On this point, I entirely agree with Deluard. The wealthy need to watch out – governments are coming for their money.
“Regardless of political preferences, this new agenda would be bad for most stocks and almost all fixed income investments. A shift from concentration to redistribution, from deflation to inflation, from monetary dominance to fiscal deficits, from deregulation to social and environmental justice, and from tax cuts to big government would be the last nail in the coffin of the 60/40 portfolio….The neo-liberal consensus of the 90s which powered the great wealth accumulation and concentration of the past three decades has lost the ideological battle and is only sustained by the weight of habit, the inertia of institutions, and the trembling hands of dying politicians.”
I’d add one final coda.
It’s from a tweet by the excellent Peter Turchin (author of the Ultra Society) who’s popularized a term called cliodynamics which combines long-range historical analysis (and forecasting) with the physical sciences.
You can see Turchin’s Twitter feed here : https://mobile.twitter.com/peter_turchin
More particularly I was struck by the chart below which shows why so many citizens are really, really pissed off and supporting populists like Trump ! It also helps explain why we are seeing such an epidemic of bad health and addiction in many white working class communities in the US.
You can see the full thread here: https://mobile.twitter.com/Peter_Turchin/status/1329846632985276416
As Turchin says “this is probably the most vivid evidence of immiseration that I’ve seen so far. From: The expanding class divide in happiness in the United States, 1972–2016. Twenge, J. M., & Cooper, A. B. (2020)”.
So, pulling together all these various strands, what does Deluard conclude we investors should worry about? In one word: inflation.
“Everything is possible but history suggests that stocks’ valuations have the same relation to real yields as they do inflation: negative is bad, a little positive is great, and very positive is very bad. The S&P 500 index’ cyclically-adjusted P/E ratio has averaged 11 when real yields have been below minus 2, which would be a painful drop from today’s near-record 33 times earnings.”
This for me feels more of a stretch and echoes the warnings of Albert Edwards and others. Possible but not very likely in my view.