Investors Should Know Not To Fight The Fed And Politicians Not To Interfere With It, But In The Current BizarroWorld What Shouldn’t Be Is: The Latest On The Global Economy

Mike Pence’s attention-seeking call to curtain the Fed’s mandate reflects not just unedifying politics but the conundrum of how the Fed can possibly seek full employment when too many have stopped working and consumers keep spending on inflated goods and services. The Fed is fighting the good fight to disinflate the US economy but the cost must be born by more unemployed people and lower wage growth. That’s a recipe for low valuations, yet the markets have shrugged off the 2022 bear market in the callow belief that a new bull market has taken over in the context of a restrictive Fed. Absurd as that is the trend remains intact, as the volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is neutral. There are several negative factors across global asset classes. Copper is 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 rise to resistance at 4210 and then fall hard as reality sets in.

While the global economy descends deeper into stagflation the financial markets diverge between the purely financial and the real. Equities and bonds are in uptrends while commodities and many parts of real estate are in downtrends. This strange set of affairs likely resolves in financial markets coalescing into a downtrend that reflects declining confidence in the merits of a stagflationary context. Key is the action in China, as this one-time engine of globalization and rising living standards is simply failing to maintain its promise.

China’s unemployment situation is skewed to its youth and this is getting worse due to the mismatch between jobs offered and wanted, particularly for well-educated youth. The reopening has lifted investment and consumption but the property sector is still falling and constraining optimism and the jobs market. The ensuing political insecurity for the dictatorial Communist Party leads that entity to fulminate against immoral and corrupt capitalists, which only worsens private sector confidence and keeps the jobs market static. The financial symptoms of this are a rising Chinese equity market driven by the CCP’s “National Team” in ugly marriage with speculators, and the deep fall in the types of commodities used by Chinese manufacturers (e.g., copper, zinc, aluminum). The nasty political dynamic suggests equities will follow commodities.

Europe depends on global trade more so than the US and consequently its prospects dim in near-lockstep with China. Germany is the workhorse of Europe and business expectations there continue to be negative as Eurozone industrial output falls negative for the year to date. At the same time inflation remains intolerably high, leading to fears of deeper stagflation and corresponding tighter monetary policy.

Japan depends both on China and its global investments, since its domestic economy has been moribund for 2 generations running. There growth and inflation are both surprising to the upside, yet the yen is declining along with nearly every other currency against the dollar. Politics and culture explain the conundrum: Japanese policies and political attitudes are too middling to reform a nation from zombie-like economic activity to the dynamism found throughout modern Japanese history up to the bursting of the bubble. And the US debt ceiling impasse along with persistent wage inflation means US interest rates will likely be high as the US economy eventually slows, helping the dollar at the expense of nearly all other currencies.

But for now the US economy continues to hum along in the bizarre context of a labor shortage, high fiscal and trade deficits, robust consumption and high inflation, with markets somehow pricing in rate cuts by a Fed that abhors this economy. The Fed always wins these fights and the decision will be communicated when equities fall and rates rise in anticipation of worst that is yet to come.

My current positions include a moderately large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a significant long position in large-cap equities.