Market Volatility Has One Final Act

My Comments: You would think that with an almost 50-year history working in financial markets I’d have a clue about what’s going to happen next with respect to our investment portfolios. But I don’t have a clue.

All I can do is listen to those whose ideas over the years have proved more accurate than my own impressions. What follows makes sense to me, but you NEVER KNOW IN ADVANCE. NEVER…

by VanEck \ 08 JUN 22 \

With inflation still in the early innings, we expect market volatility to continue – but we’re certainly closer to the end with opportunities starting to emerge among oversold assets.

When Will It be Over?

The short answer: not yet. Financial tightening by central banks is never good for financial assets. And while the first half of 2022 has already been painful, we are only now in mid-summer, experiencing the onset of “quantitative tightening,” which is when the central banks stop buying bonds. This, to me, is the final act in this process, and it may take a few months to work itself out. I am hoping that there are no implosions by major, indebted countries, or major dislocations in fixed income or banking markets.

The second signal that will imply less pressure on financial markets – stocks and bonds – is weaker labor markets, because only that, I believe, will slow wage pressure and therefore, inflation. While there will likely be many minor signals and headlines, we may not have confirmation of cooling wage pressure until year-end or into 2023.

For over a year, I’ve been saying that we would be in a better position to gauge inflation persistence once we know whether inflationary psychology has affected wages. Despite a cooling U.S. economy, the labor market is still hot. There is a strong relationship between wages and inflation, which historically becomes more pronounced during periods of high inflation. Based on the fact that the record-setting spending stimulus has led to wage inflation, our view now is that inflation will be higher for longer.

Rolling 3-year correlations of the 3-year averages of U.S CPI Urban Consumers to U.S. Unit Labor Costs Non-Farm Business Sector. (TK – there’s a chart here that I was unable to replicate on this post. To find it, simply go to the link associated with the writer of this article.)

While I expect to be in an elevated inflation regime for an extended period of time, there should be some temporary relief on the horizon from the negative wealth effect of declining asset values, a recent pullback in commodity prices, and improving supply chains. But asset values can still fall further from here, commodity prices are still high by historical standards, and supply chain pressures are still at last summer’s levels.

Consumers are being squeezed by high inflation and more restrictive, yet still accommodative, monetary policy. I estimate the evisceration of over $40 trillion from the global stock, bond and crypto markets as a result of the current macroeconomic conditions. That equates to nearly half of the world’s GDP!

With the Consumer Price Index up 8.6% in May, the market sees the Fed Funds Rate reaching 4%. Given the rate of inflation, it’s hard to believe that long rates have peaked, so I see the 10-year Treasury rate potentially going to 4% as well. The market has probably priced most of this in now. The Federal Reserve began its quantitative tightening in June, and I am watching for breakage in the credit market. So far, so good. Credit spreads have widened to 5-year averages, and if we’re correct in our assessment, the recession has not been priced in yet.

Watching China’s Economy

At the same time, the markets are concerned with slowing growth in Europe, the U.S., and China. As one of the biggest drivers of global growth, China’s economy should be watched closely, and it dipped into recession territory. China’s PMI numbers for both manufacturing and services have been in the contraction zone for several months, and it’s surprising to investors that there haven’t been more stimulative policies this year.