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Macro-State Discussion

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23 January 2023

Moritz: How are you seeing current developments and the outlook? Is there something i should urgently look at? Should i think about reducing investments a bit right now, given the recovery or is the picture looking better already compared to 1-2 months ago?

Magaly: It Depends in your view about current data:

Markets right now are probably reacting to:

- CPI coming down and expectation for the lower trend to continue this year

- FED will most likely pause soon, and markets are pricing rate cuts this year contrary to what the FED has said. https://twitter.com/biancoresearch/status/1613215357166043137

- China reopening could boost global demand: https://www.bloomberg.com/news/articles/2023-01-18/china-reopening-could-boost-2023-global-economy

- Markets are pricing a small chance of a possible recession or at least a serious one. https://themacrocompass.substack.com/p/recession-or-soft-landing#details

IMO, markets are expecting that just a very soft economy weakness will cause the FED to cut rates in 2023, and the growth cycle will start again. I am not sure it is realistic. Either we have a soft landing and the FED can follow their plan, or we have a recession that will force the FED to cut rates.

But US economy is now weaker than 1/2 months ago:

The only thing for the economy still looking strong is the labor market, which is very lagging. And actually not good for markets because it will give more room to the FED to continue with high rates for a longer period, even if the economy is already weakening.

My opinion is that as long as unemployment stays low, the FED will not care about any other economic data. They will react only when unemployment starts to rise (unless there is a credit event). This could be very damaging for the economy as an end result, companies have suffered from labor shortages, they will not be so quick to layoffs employees this time compare to other contractions.

I am never comfortable telling you what you could do with your portfolio because the stock market is not my expertise, and I have never tried to time the markets. But still looks like a bear market rally for me. I do expect these rallies to continue though, especially when the FED pause and everything look relatively stable, but I am also expecting another decline when the economy is in full recession, which I think the market is underestimating at this point. I could be wrong, and we could achieve a soft landing, but the economic data coming out recently is not align with this, at least not yet, so I see the soft landing narrative with a low probability still.

As for earnings, I don't expect EPS to show that much weakness in these first quarters since the economy has just started to weaken recently. If EPS falls significantly, it could be much later in the year I think if I were in your position, I would wait for more confirmation, right now there is not a clear path in either direction.


Moritz: What's your evidence that the fed is going to pause soon?

I actually thought money supply would have contracted more by now (Ig we should start an article about it) It going down very slightly is not that bearish to me.

Overall the important question to me is not if there is going to be recession, but if there is one how bad is it going to be?

The answer to this question in combination with our assessment of mid-long term interest rates will allow me to make better judgements when it comes to valuations.


Magaly:

  • About the FED pausing and then cutting later in 2023, it is what the market is pricing in, not my opinion necessarily. Everyone is almost agreeing hike cycle is coming to an end soon because CPI is coming down. Personally, I think they will hike (25bps each) in the next couple of meetings or even 3 meetings, and after that pause. My guess is that will happen when core inflation is below rates, and stay there for a while to see how inflation reacts, they have said their aim is to reach positive real yields at some point. This will most likely happen in coming monts, unless we see acceleration in inflation, but is not very likely with current data.
  • When it comes to guessing how bad it could be, we would need models which we dont have at the moment, and I don't have experience building models either. I could only guess based on how bad data becomes, and some historical correlations, but not with very high confidence to be honest. We would probably need to bring other people arguments and opinions into account for this. And at the moment there is zero consensus, there is no even consensus if there will be a recession or not. I think even people that have models, don't know for sure.

Either way, what I could say at the moment is that, even if it is a mild or a severe recession, stocks stills seem overvalue compare to what other bottoms have looked like. And comparing to other assets, they are even less attractive now to hold. Unless you think the soft landing is possible

I like this Bridgewater article explaining this: https://www.bridgewater.com/_document/how-conditions-today-compare-to-past-equity-market-bottoms?id=00000184-4485-d0fe-a9c5-c49dd5ff0001

Details: https://www.investmentwiki.org/wiki/Analyst_Opinions

Moritz: On the assessment of bridgewater: My first two concerns that come to mind are 1) The amount of money. I am unsure how to judge the massive amounts of liquidity in the market. They might cause P/E ratio to stay higher compared to other times in history (At one point we need to study the liq situation esp. compared to history) 2) There is that arguments that investors could have learned from past recessions and things might play out differently. (E.g. more buying earlier when longterm opportunities open up) This argument probably does not make sense at all - as history always keeps repeating itself. Nevertheless i am interested in arguments why exactly things should behaving similarly than in the past.

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