As you indicated that bond yields have risen, crude oil prices have skyrocketed and now the Fed has raised rates. In your understanding of macros, how will the sequence unfold now?
In a typical macrocycle, there are all the things you mentioned. In parallel, a war and massive volatility of crude oil must be launched, part of which has taken place. The Fed lowered its growth estimates yesterday and, of course, on the supply and demand side, inflation still remains an issue. They were rather hawks. Sure, the markets celebrated it because the peak of the war is behind us, oil has subsided but two-year treasuries have actually risen by 10bps.
So, in a way, we are entering a situation where the Fed is raising rates after a long time and are actually starting to reduce growth estimates. There has been a rather substantial decline in growth or rather a reduction in the growth estimate for 2022 from almost 4% to 2.8%. The yield curve has narrowed quite substantially. It is now only around 23-24 bps. Many commentators have heard of how the risk of recession in the United States has increased.
So what a wonderful six month transition that was. In September we were discussing Goldilocks, Easy Forever, Forever Low to Very High Crude Oil Prices, High Metals Prices, Super Tight Fed, Super Aggressive, and of course Europe, the Nasdaq and many markets. like Turkey, Russia are becoming completely decimated. So the transition globally took place from mid-cycle to end-of-cycle and some sort of bleeding has already occurred in many markets.
We should discuss India separately, but this is a great macro setup as I see today.
If asset prices are a function of interest rates and if interest rates will rise and if there is a fear of a real slowdown due to what is happening to Russia, what will happen to Europe due to energy and what is happening to China because of Covid then we are in rough days. Does bumpy mean you fall and fall hard?
You are absolutely right. Basically, we don’t live in routine times. At least in the last 35-40 years, especially in developed economies, we have never had a transition from low inflation to not only high but extraordinarily high inflation when growth conditions are actually weakening. This is the problem of inflation. When inflation is moderate, it works as a lubricant, but if it’s very high, it actually starts to work as friction and because it dulls consumer sentiment.
We saw that in many European countries and, of course, more specifically the United States, consumer confidence dropped to levels when we saw the falls in March 2020, when the Crown was first surging and people were scared. This is the kind of configuration the consumer is in now.
A week ago a survey was conducted in the United States where most people actually think the US economy is already in a recession and that’s the average thinking. So the point is that inflation is a losing trade for all assets and for the economy and that is why Powell also stressed last night at a press conference that price stability is a precondition for growth and full employment.
We all know that inflation hurts consumers but also hurts companies, contrary to what many bottom-up investors believe because in hyperinflation situations such as in the United States and perhaps even in Europe, earnings do not keep up with inflation. and the markets start quoting higher yields forever to discount future cash flows and thereby lower the PE, which is what happened in the 1970s.
My opinion is that the approach we are in right now cannot be compared with 2003-2008 or 2010-2018 or 2018-19. Obviously we are not in the 1970s situation as far as the United States is concerned, but there are many signs that conditions are very rapidly becoming like those of the 1970s, when both supply and demand shocks coexisted and could very well become a double drop a kind of configuration for the economy and for the asset markets we are already seeing a lot of volatility. Hence, these configurations create a lot of volatility with a bearish bias.
You said earlier that you should stay passively invested because there was too much volatility and this is not the time to compound risk. But with a big global event out of the way, would you say now is the time to change your strategy to start distributing money or even start increasing risk?
If we shrink somewhat, as we have discussed investing passively and staying out of the small and mid caps in active betting. Over the past six to seven months, markets have gone from the price of less than a Fed rate hike in July, August and September to seven hikes this year. Oil is no longer a speculation, it went from $ 70 to $ 100 and stabilized there, with or without war. India’s current account deficit has moved from 1.5% to 3% and is actually flashing further.
Read also: We are in a shock situation; this is not the time to compound the risk
A geostrategic decoupling and a world split: to some extent an economic decoupling is taking place between the fields of the United States and China. And of course the growth numbers have pretty much been revised everywhere. There is a serious risk of recession in Europe, I would say ¾ possibility and ¼ possibility that there is a recession in the United States. Indian growth numbers have actually been quite abysmal. We have seen IIP numbers; we have heard comments from many consumer and durable actors; we have also seen a general decline in growth in India.
I fear that from a transitional point of view, now we have to think about whether we are already at an advanced stage of the cycle and therefore, instead of being involved in passive investing, I would actually make a further withdrawal and would say that I would start to raise further money.
The rally in today’s markets and the fierce rally we have had over the past two, three days would still occur in a negative environment because it is about positioning. But I still bet this boom cycle in both the economy and equity markets may already be over and we are seeing markedly slower growth not only in the US and the world, but also in India over the next six to 12 months, with the double dip risk and a significant risk that asset markets will continue to underperform for the next six to 12 months.