The Latest On The Global Economy: Powerful Governments Are No Match For Economic Complexity

Bear markets reflect under-confidence in society and the actions of governments across Eurasia and the West give ample reason to bet against the global economy. Now that the $US is raging back to the highs of 20 years ago global GDP growth is bound to slow to a crawl, which will further decimate financial markets and create a negative feedback loop that potentially spills over into 2023. Consequently 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. 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 over the next few days.

One of the underconfidence measures driving markets is resignation over increasing statism. Western government responses to the economic problems of 2022 have been largely impotent, a stark contrast to the state’s largely laudable role in dealing with the pandemic. Economic problems are complex and reflect competing goals, thus rendering most states incapable of altering market trends or private sector demands. The pandemic by contrast reflected a clear goal and a discrete number of factors which scientific thought could easily consider and act upon.

Inflation, commodity shortages, low labor force participation and COVID lockdowns in China make for a multifaceted economic problem which governments can only mitigate, not fix. The US has successfully avoided recession so far, but equity markets forecast one coming up and bond markets are ensuring that happens by raising the cost of mortgages beyond middle class affordability. But recessionary fears are deeper elsewhere, and even radical pro-growth policies coming from new UK PM Truss are doing nothing to alter market sentiment. Her Reaganesque package hasn’t shifted sterling a penny higher since an overleveraged and underproductive nation can do little to ignite growth except commit to getting out of the way for the long term.

Japan’s yield curve management has done little to generate growth and now their remarks about the pace of the ¥’s slide are making no difference. More importantly, US Treasury Secretary Yellen hasn’t signalled that UST would be willing to contribute to an intervention, which historically has been key to such interventions actually stopping a trend. Similarly the ECB’s signal of tighter monetary policies hasn’t kept the € above parity, or business and consumer expectations from pointing the way to recession. And worst of all, China’s contradictory policies are leading the Yuan’s slide while natural and man-made disasters gradually erode confidence.

Key to reversing the economic malaise is a resurgent US since the American consumer is the world’s consumer of last resort. Diffusion indices continue to show moderation rather than a deep recession in the future, giving some hope the Fed can still engineer a soft landing. But the message to markets is to wait and see, which leaves no optimism for valuations to stay even. Consequently I expect a retest of the June lows this month, and possibly lower lows in October.

My current positions are a very large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which nets to a moderate short position in equities.