Your weekly input on the global economy, financial markets, megatrends and more.
I’ve been on a coaching course all weekend and it has only confirmed to me how many similarities there are between coaching and teaching in primary schools, vocational schools, colleges, universities and other educational institutions. Good coaches can take players who at first glance are miserable and with very little ball in them to very high levels, even the very highest levels, and win championships. Similarly with teachers – we’ve all experienced this in one or more subjects.
That’s why I still wonder what we as a society choose to spend the money in the treasury on – and not spend it on.
Well, no more petty political philosophizing from a mediocre coach trying to improve his skills.
Regards Frank
- Biden has lost the trump card that can keep oil prices down and therefore we now risk oil prices of $100-125 and inflation rising again
- The importance of the G20 meeting for investors according to Paul Donovan:…………………………………….
- India is in the midst of an infrastructure boom, making it increasingly important for the development of commodity markets
- Brazil’s importance to the world economy is also growing – now in corn!
- Fiscal dominance has now also come to Denmark
- 80% of all dollars in circulation have been created since 2020 (!)
- Bonds have been riskier than stocks in this business cycle
- Equity pessimists believe the plunge in equity risk premiums is a harbinger of a looming equity downturn ahead, but historical data shows that this is not the case
- On the other hand, the low equity risk premium says something about the potential of equities vs. bonds in the long term – and it is falling sharply
- Gavekal believes that the price development of bank shares gives an indication of which stock markets have the best potential in the coming years – Japan and Emerging Markets
- The ratio between tech and small cap stocks is at its most extreme level ever and back to the peak of the IT bubble
Risk of $100-125 oil prices and re-acceleration in inflation and Trump as president
Oil prices have risen 25% in the short term and the limit on sales from US strategic stockpiles has ended, while demand for oil is reaching record highs and therefore oil price increases could be even greater. I wrote about this in my latest column in Politiken (In Danish!):
Conclusion
The crisis talk has stopped and oil prices at $80-90 are not a problem for the world economy, but they start to become a problem if we are talking $100-125. According to some commodity experts, the situation is extremely tight in the oil markets, so the risk is real.
So high prices would be good news for Saudi Arabia, Putin, Trump and oil and gas stocks, but bad news for many ordinary people and their spending power.
G20 meeting of no significance for financial markets according to UBS
This weekend’s G20 political summit has received a lot of media coverage and plenty of analysis has been released. Paul Donovan, chief economist at UBS, always worth listening to and ready with a dry English commentary, has the following succinct analysis this morning:
Conclusion for investors
Don’t waste time on this
Construction boom in India increasingly important for commodity markets and the global economy
The G20 meeting in New Delhi may not have been that interesting according to Paul Donovan. However, the whole infrastructure and construction boom in India is, where public investment in this fiscal year increases 37% to 10,000 billion rupees = 120 billion USD or approximately 800 billion DKK.
Good article from Wall Street Journal
Conclusion
India is being seen by more and more commodity experts as a major new swing factor in the demand for many commodities. Nothing close to China when it was booming at its peak, but closer to China now and certainly a factor not previously considered. India, unlike China, needs significantly more infrastructure investments (see the two images below).
Brazil has taken the corn crown from the US
The next G20 meeting is in 2024 and will be held in Brazil, which, like India, is becoming an increasingly important part of the world economy without reaching the heights of China. What happens in Brazil is important for some commodity markets, such as corn as shown in the graph below.
No more: Fiscal dominance has now reached Denmark
The global pressure on fiscal policy and to open up state coffers and spend freely – what is known as “fiscal dominance” – has now also come to Denmark. The pressure from interest groups, mayors, citizens and employees is too great when the coffers are overflowing.
Conclusion
Fiscal dominance – when fiscal policy becomes so loose that money flows out of government coffers and dominates monetary policy – simply means harder work for central banks to control inflation and an increased risk of higher interest rates for a longer period of time.
The few billion DKK in extra public spending in Denmark makes no difference in the big global equation, and unlike many other countries, we have the money in the treasury and are not running gigantic deficits. But the whole development and the social debate shows something about the zeitgeist here in the fourth phase of capitalism compared to the neoliberal third phase we have waved goodbye to: More state control, more state power, less free market capitalism.
Don’t underestimate higher interest rates – things take time
Two short inputs on interest rates, money and inflation etc. Jim Grant and the US money supply, respectively:
“It was the zero-percent era that made a 5%-plus rate dangerous.”
- Investor-guru Jim Grant
80% of all dollars in circulation are created in the period 2020-2023.
And here are the latest money supply figures from the US:
Conclusion
Don’t underestimate the impact of higher interest rates, especially when it follows a long period of very low interest rates and lending to all sorts of people. That’s basically the message from Jim. Some money is lent to investments that make sense even in a 4-6% interest rate world. Others are not so smartly lent.
That’s what we’re slowly finding out over these months. It’s slow because many have borrowed at low interest rates and money has been so plentiful. Unless interest rates fall sharply again soon, things will continue to tighten. Housing markets will also feel the pinch, even though many countries are currently doing slightly better again. One exception is Japan, where higher interest rates will be positive for the economy.
Federal Reserve is a firm believer in the soft landing
The big talking point in the US is the below statement from a key Fed executive to Bloomberg news media and the article in the Wall Street Journal – where the Fed often sends new signals – that the Fed is pausing rate hikes for now.
“All the talk of us having a recession has vanished”
- John Williams, head of the US Federal Reserve’s important New York branch
Conclusion
The sarcastic among economists and investors are broadcasting similar headlines and statements from 2007, shortly before the financial crisis broke out.
Bonds have been riskier than equities in this business cycle
In classical portfolio theory, bonds are considered less risky than equities due to lower volatility in returns, which is the finance and economics world’s strange definition of risk. If you instead look at “drawdown”, i.e. the maximum amount of capital/wealth you can lose from a peak to a trough, bonds have been riskier in this economic cycle as measured by US data.
Conclusion
When buying bonds at zero or even negative interest rates (inflation-linked bonds even at guaranteed negative real interest rates), as has been the case until recently, the term yield-free risk for bonds was appropriate. Today, bonds look somewhat more attractive due to higher yields – how attractive depends on inflation over the next 12-120 months, which all economists and investors are struggling to figure out and deeply disagree on.
Equities no longer attractive compared to bonds, but rarely decisive in the short term
A major focus point in the financial markets in recent months is that the simply defined risk premium on equities (earnings yield, i.e. inverse P/E less the long-term 10-year yield), especially in the US, has plummeted due to higher interest rates and higher P/E at the same time and is now close to 0%. In other words, bonds have become cheaper (more attractive) and equities more expensive (less attractive) over the past few years.
The two nice graphs below from Bespoke Invest show that, unfortunately, this does not give much indication of where the stock market will move in the next year. There is no correlation between whether the risk premium on equities is high or low and the return on equities over the next year (the y-axis on the bottom graph is hard to see but measures the return over a one-year period).
Conclusion
Many “bears”, i.e. equity pessimists, use the sharply declining equity risk premium as an argument that a major equity downturn is just around the corner. There may well be, but there is no evidence that this is related to the equity risk premium based on what we have seen historically.
What the low equity risk premium tells us is the long-term potential of stocks versus bonds, and it has deteriorated significantly.
What do bank stocks say? Japan and Emerging Markets
One of the founders of the research house Gavekal, Louis-Vincent Gave, has come out with a short analysis of what the development in bank shares reveals. His view is that banks are the heart of our economies and that countries where bank share prices are weak are difficult to make money in because banks will be reluctant to take risks, which reduces lending, growth and the price of the country’s stock market. Below you can see the development of bank stocks by country and Louis’ own conclusions.
Conclusion
According to Gavekal’s analysis, bank shares in Japan and Emerging Markets are sending positive signals about the development of their stock markets, while things are not looking so good in the US, China and parts of Europe. However, the broader stock indices in Emerging Markets are still lagging behind (partly due to China), while Japanese stocks are already rising nicely.
A few extra graphs at the end
