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Who doesn't love a good prediction about the future?
It's the time of year when everyone takes a break, picks an arbitrary measure of time such as the number of rotations around a giant ball of hydrogen, and then proclaims that 2022 will be [insert predictions].
The initial instinct is to dismiss all of it. Nobody can predict the future so why 'waste' attention? I respectfully disagree.
To me, this time of year brings an opportunity to see where the market zeitgeist is focusing. Massive neon signs pointing towards a labyrinth of rabbitholes...
A couple of things already have my attention.
First up, regime change. 👇
John Authers explains:
This could be the year when the global economy enters a new regime.
No longer driven by minimal inflation in prices, negligible interest rates, steadily falling bond yields, growing inequality, and fantastic returns on asset prices, it’s possible that the return of rising prices in 2021 will at last force a new way of doing things.
With inflation a serious practical problem for the first time in a generation, the assumptions that “there is no alternative” to stocks, or that independent central banks can defend confidence in the currency, finally come into question.
But nothing is certain in the exceptional circumstances that follow the pandemic, and as markets still try to digest the unprecedented interventions to deal with it.
In theory, the explosion of inflation this year should have driven a big rise in bond yields, and might well have dragged down share prices.
Nothing of the kind has happened.
Will the market regime finally change in 2022?
I've bolded the bits that really caught my eye. Needless to say, I still think the jury is out on any kind of lasting regime change. Let's take a look at the components mentioned:
- Minimal inflation in prices is one that I'm VERY reluctant to permanently discard, although there are risks to this perspective: Greenflation, increasing labour costs due to fewer available workers, widespread underinvestment in the 'physical' economy to name a few.
Ultimately, will the triple D's win out?
Debt, Demographics & Distribution of Income
Back in 2016, BOE's Gertjan Vlieghe argued that:
Changes in the 3 Ds are interacting powerfully to create an environment where a given level of growth might be consistent with substantially lower interest rates than in the past.
This environment might persist for years, even decades.
Demographics continue to play their part, and low labour force participation rates have persisted for longer than many predicted.
Distribution of income is still highly unequal, although there are signs that the gap has narrowed ever so slightly due to labour market dislocations, especially in the lower wage jobs.
Overall, Debt is higher than it was pre-pandemic, but assets have also generally increased in value.
As we mentioned back in June, the US consumer remained strong and the exit from this recession was unlike any other. 👇
This is nothing like 2008 when every asset had to be re/de-valued and there was no confidence in the solvency of banks or individuals.
That lack of confidence led to a credit crunch.
This time, the economy has not slowed as much as originally feared.
Banks are full to the brim and ready to lend.
Borrowers have actually paid down debt during lockdown while assets have generally appreciated in value.
If ever there was a time that lenders and borrowers should be in sync, this is it.
- Banks want to lend
- Households are less indebted
- Collateral (assets) to secure lending against has (have) increased in value
It seems likely that consumption/demand will remain solid in 2022, albeit not juiced up on government stimulus. Base effects will likely have the opposite effect and see inflation lower than 2021, yet higher than 2019.
I struggle to see a regime change for any of these:
negligible interest rates, steadily falling bond yields, and fantastic returns on asset prices
Interest rates are still negligible and rates markets clearly believe that will persist.
As for the steadily falling bond yields and fantastic returns on asset prices...
All those savings have to go somewhere.
Which probably explains why the bond market shrugged off the inflation explosion of 2021.
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The Great New Dawn
This one is from Merrill:
The New Dawn means a transition from a pandemic-led, pent-up demand cycle with multiple waves of growth to a potentially lower and smoother, but still-above-average, nominal economic growth cycle.
Inflation will remain a force that lasts longer than most expect, in our view. However, this could propel revenue growth in areas of strong pricing power and keep the profit cycle from rolling over too quickly, even if the Fed pivots more aggressively.
The Great New Dawn is our version of the beginning of a post-pandemic world. This is a world led by the continued acceleration of innovation, balanced removal of a record level of global monetary accommodation, a shift toward infrastructure redevelopment, and a consumer that more aggressively shifts their spending toward services, including travel, leisure and entertainment.
The Great New Dawn is the first light of a new “post-pandemic” day.
This era will contain new shifts, adjustments, some major pivots, and further structural changes away from what dominated the pandemic cycle as well as the post-Global Financial Crisis (GFC) period over a decade ago (Exhibit 1).
Still, we believe a few core catalysts and concerns will likely remain.
These include above-average nominal gross domestic product (GDP) growth, elevated inflation, labor market shortages, energy dislocations, a strong private sector, wage growth, new coronavirus variant concerns, worries over the U.S.-China relationship, and an Equity asset class that is still significantly favorable relative to Fixed Income.
All of the factors mentioned are sure to feature heavily throughout 2022, but what is the catalyst for this regime change or brand new dawn?
The structural change seems to revolve around labour shortages, yet declining workers has been a feature of the prior regime... 👇
Summing up, I'm still at a loss to see how any new regime is supposed to manifest when the longer-term trends (The 3 D's and technological disinflation) seem as entrenched as ever.
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