“The tipping point is not a question of if, but when”
The number of threats facing markets; from inflation, central bank hikes, war, geopolitics, recession risks, corporate earnings and bond liquidity are legion. The big risk is they combine into a chaotic tipping point, at which moment we will just have to pick up the pieces…. Again.
Its Monday morning again, so time for a quick snapshot of where the merry dance of markets shall lead us this week. The sun is shining, a heat dome approaches, but I can’t help but worry about the coming storm…
The summer somnambulance should be upon us – investment desks and traders sitting back to watch their carefully composed portfolios and positions cruise through the summer before the markets get hot again in September. At least, that’s how I remember the long-balmy days of my market childhood back when I was a young banker….
Not this year. Too many fundamental tremblors threaten to rock the markets:
Inflation, Inflation, Inflation
Supply Chains, Covid and China
Europe and the ECB
War vs Jaw
Central Banks tightening
Stock Resets and Earnings
Bond Market Meltdown
Global Trade Reset and De-Globalisation
The US, The Dollar and Trump
I predict a stormy Q3 – the usually calm languid dog-day markets of July and August being replaced by lumpy seas of bad numbers, grey storm skies as markets struggle with the acceleration of negative news-flow on inflation, corporate earnings, markets and increasingly wobbly politics, and few sharp pointy rocks of financial destruction.
It feels like we are spiralling into something messy.
Inflation headlines dominate this morning. As the Fed gets ready to hike rates to combat the highest inflation in 40 years, the FT reports the US is likely to plunge into recession next year, citing the FT-IGM survey of academic economists. (Really… who listens to economists?) The UK economy actually shrank in April because of surging prices hitting the economy.
It’s at times like this when markets become vulnerable to an increasingly chaotic narrative. Chaos quickly becomes chaotic as surprises and unexpected events spin up instability and feed each other. Suddenly we get the chaos moment, the tipping point, where markets jump out their expected ranges and become impossible to rationalise.
Maybe the straw that triggers the breakout will be an unexpected corporate event like a default, failed acquisition or profit warning? Maybe it will be something in Ukraine or the South China seas? Maybe it will be elsewhere completely? It will come on the back of a stream of reinforcing bad news, then another and suddenly the whole edifice of markets is on the slide. Maybe it will be something from the televised inquiry into the Jan 6th 2021 US capital riots? It will happen, and the next day or whenever the hurly burlys done, we try to put it back together again.
As the stronger-than expected US inflation number showed on Friday, no amount of central bank steers on supposedly “transitory” inflation adjustments to the post pandemic supply chain reopening are going to steady this market. Negative news – whether its Russian gains in Ukraine, renewed lockdown in Shanghai, or the Fed tightening US rates at this week’s FOMC by 50 bp are unlikely to support markets. They are more likely to test further downside.
There is also a certain amount of hope prevalent in this market – that central banks will step into stabilise markets, to bail out crisis and restore calm in their usual way…. throwing more money via QE at an enfolding crisis. The market knows this is possible, even probable in some cases, so it is prepared and ready to buy the moment.
While the Fed will Hike on Wednesday, and the Bank of England on Thursday, the ability of the ECB to follow through with a 25 bp hike in July is being questioned around the market. Italy is seen as the crisis point – no surprise. Fragmentation – European bond yields widening dramatically to Germany, illustrating the respective and relative economic weaknesses of each nation – is the new buzz-word in Yoorp’s bond markets.
Christine Lagarde, the ECB President and French politician, has made clear “new instruments will be made available” if “fragmentation” might “prevent adequate monetary policy transmission” – which, when translated means: if Italian bond spreads widen to Germany and threaten any kind of crisis, the ECB will act to tighten them…. By reopening Italian bond buying. Whatever it takes remains just that – which rather suggests a buy European sov bonds moment is coming. Italy bonds are currently 224 bp over Bunds. Get your buying boots ready to buy at 250.
The War in Ukraine looks stalemated, with little prospect the West will do more to supply the oomph Ukraine needs to avoid an attritional Russian win. There is an increasing sense the West’s appetite for a punishing economic war is fading – especially in Southern Europe. That wavering support will have all kinds of geopolitical consequences in terms of oil prices, growth, commodities, and the lacklustre global support vs Putin we’ve seen outside Europe and the US. (Later this week I will risk a comment on why the US is losing the plot.)
Increasingly the unwillingness of the oil producers to favour the West vs Putin highlights how the role of the US as global hegemon has broken down. Around the globe, the geopolitical trend is to look past the US and figure out the new fault-lines. Yet, the dollar remains the de-facto safe-haven trade. Last week I cited US Treasuries as the safety trade when it all goes wrong. Just how quickly could that change? When the pound sterling was knocked off the perch decades ago the dollar was the clear successor… today? Not so clear. I am favouring gold in the meantime.
In China, renewed lockdowns and the sense Covid controls have become permanent has confirmed a massive internal consumption shift has occurred. I really don’t expect to visit China any time soon, if ever again. However the XI ascendency paint it, the economy has been locked and will become increasingly internalised – and that’s just one sign of how the global economy is de-globalising.
Back in the real world of markets, I’m wondering what Q2 earnings will reveal. Just how strongly will they illustrate how inflation is beginning to snipe down retailers? How much of the pandemic economy was built on foundations of sand? (Great piece in the WSJ about how the pet-care business will prove to be a lastingly solid pandemic investment – other sectors? No so much.)
When the central banks stop buying corporate bonds, and big funds are publicly announcing they are short credit markets and long corporate default swaps, you can feel the liquidity drain out the fixed income credit market. (Fortunately, should you find yourself in need of shifting large corporate and bank debt positions – give me a call.. I have a plan. It’s as cunning as a cunning fox with a spade outside the chicken coop.)
My conclusion – whatever the market commentators are saying about a summer slowdown, don’t listen to them.
This market has so many hot-buttons with Don’t Panic printed on them, primed and ready to fire, its looking close to a chaotic breakout. Which will hurt, but spell opportunity. The problem will be acting on opportunities when a liquidity crisis in corporate bonds locks down all markets.
Remember that in market crisis its not what you want to sell, but what you can sell that matters.. (Might have to add that to my list of market mantras!)