Britain’s Liz Truss Has An Answer To The Rise Of the European Radical Right But The Markets Are Asking An Entirely Different Question: The Geopolitical — Stock Market Connection

With supply shortages emanating from numerous sources in America, Europe, Russia and China, the markets are asking global leaders what do demand destruction policies have to do with righting the world? The answer from central banks is openly economic but secretly cultural, and since inflation has remained stubbornly high traders can do little but sell off capital assets and wait for the lead central bank — America’s Fed — to call a pause. That’s not enough for the new British leadership, and consequently they’ve unleashed a bold plan to reinvigorate their nation and offer the world an alternative to the statism envisaged by the neo-fascists and their ideological cousins in Eurasia. Sadly their timing is terrible and not only are markets punishing them for it, but getting disorderly about it. The volatility risk premium points to a market fall over the next few days, while my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes. Gold is trading as a risk-off asset. Copper and Oil charts are pointing to declining global GDP expectations. The action in currencies signifies $US strength. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to fall hard over the next few days.

The notion of something breaking and unleashing contagion on the global economy was given a sudden impulse with the break in the British Pound Sterling yesterday. Pundits noted such a large and volatile intraday move hadn’t been seen in modern memory, and Larry Summers connected this with the special status of the UK in the global economy. Summer tweeted “Financial crisis in Britain will affect London's viability as a global financial center so there is the risk of a vicious cycle where volatility hurts the fundamentals, which in turn raises volatility,"

The fundamental issue is the liberal ideology that Liz Truss and her Chancellor Kwasi Kwarteng espouse as a way to leverage Brexit into a win for the UK, all the while Europe shudders and declines due to their exposure to Russia and Ukraine. The PM and Chancellor are economic liberals like their hero Margaret Thatcher but free of the vague social conservatism that Thatcher projected in her demeanor but articulated poorly. Their liberalism merges neatly with supply-side economics and since they recognize the high status Ronald Reagan enjoys with conservatives and the immense nostalgia Americans have for the go-go 1980s, they’ve naturally devised a policy plan that envisages a Britannica version of that heady time.

The problem they’ve comically brushed aside is that Britain in 2022 doesn’t possess a major reserve currency like America did and still does, nor low debt-to-GDP (as America once did) nor a balanced current account (let alone a surplus like many Western European nations). So any busting of the budget deficit at a time of supply constraints can only feed inflation and lower the value of the £ so that a vicious cycle runs hot until and unless the Bank of England steps in to raise interest rates and choke off any growth intended by the supply-side policies. The end result is simply more debt and nothing to show for it.

The Economist notes “At an annual cost of over 1.5% of GDP, the tax cuts alone are worth the most of any budget since 1972, according to the IFS. The comparison is uncomfortable, since that year’s budget—also premised on unleashing economic growth—started Britain on a path to crisis that culminated in an IMF bail-out in 1976…And high interest rates will whack homeowners, the bedrock of the Conservative vote. An interest rate of just 3% today results in mortgages that absorb the same share of income as a rate of 14% did in 1980, after adjusting for the fact that mortgages are bigger and mortgage interest is no longer tax-deductible, calculates Neal Hudson of BuiltPlace, a housing website.”

So traders are resurrecting dreams of being the next George Soros and thrashing the £ while the PM and her Chancellor try not to reverse course. I see this playing out over weeks rather than days because Liz Truss is not an elected PM and thus has a double burden of not only making a positive mark but of defining herself for an electorate that never got to know her. And since her ideology solves the fundamental Tory dilemma of how to properly distinguish itself from the social democratic inclinations of the British Left (i.e., Labor and the Lib Dems) without going against the inherently liberal attitude of most Britons, she’s unlikely to reverse course right away.

Worst of all is that her analysis is likely spot-on. Her liberal pro-growth ideology that’s shorn of any social conservatism is a modern day variant of ethical individualism, the historically British but inchoate ideology that merges Bentham and Mill (Utilitarianism) with Adam Smith (free enterprise liberalism) with the religious liberalism inherent in Britain’s attitude toward dissenters and nonparticipants in the national Church of England. Ethical Individualism is the idea that people should pursue societal betterment in any way they perceive by forming groups or if need be alone, rather than being sponsored by the state or any body with a measure of coercive power (e.g., the CoE). This broad but also bounded definition of individualism is based on an agreed morality in social relations that the British have long demonstrated, which can be called Pauline solidarity (i.e., resonant with the teachings of St. Paul, who weighed in on diversity and tolerance). Britain can resurrect its influence on the world by leveraging such grand contributions to knowledge, culture and art, and Truss senses that all the nation needs is a leader who articulates that with passion and no small glamour. Were this 2021 she might have had a real chance to make her mark.

Now equity, bond and currency markets are re-rating while commodity flows are reorienting as a result of the War in Ukraine and the COVID policies of Xi Jinping. The financial and economic retrenchment hitting every region of the world demands probity from leaders in order to maintain underlying confidence and minimize the bottoming process. But Truss and in particular her Chancellor don’t project probity and are woefully offside. This is a key reason global equities will break to deeper lows and put off the next bull market until sometime in 2023.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and SPXU, all of which still nets out to a meaningful short position in equities