I think we are currently in a hugger-mugger market. This means that bad news is really bad, and good news isn’t necessarily really good for stocks.
Let's explain this concept with a bit of a twist by going through the previous market environment.
I’m sure that many of my readers have heard the term upside-down market. It refers to a market situation in 2020-2021 when bad economic news was actually good news, because it meant more stimulus from both central banks and governments. Investor legend Stanley Druckenmiller has suggested that the best market environment for investors is slow economic growth that Fed is trying to kickstart with all the means. This was the situation for more than ten years after the financial crisis.
Stimulus supports equities by improving liquidity in the market, while at the same time the government stimulus supports earnings on the economic side.
When the state pours money in, put a bucket underneath. Public stimulus directly fuels economic activity. As the government employs recovery measures, money eventually finds its way into the accounts of individuals and businesses, further boosting consumption and investment.
Such an overview is a crude generalization, but at the same time simplification can provide essential insights into the market. I think the upside-down market was a truly mind-expanding concept at the time and it encouraged people to buy stocks cheaply during the pandemic, despite the threats.
The upside-down market was practically broken in fall 2021, when inflation spiraled out of control, forcing central banks to react aggressively. The most effective way to cool the economy is to tighten monetary policy, for example by raising interest rates and restraining public spending. Of course, both methods are harmful to the stock market, like investors have felt in their own skin. While central banks almost everywhere in the world have tightened monetary policy, governments haven’t done the same to close their deficits. Of course, the energy crisis has provided an excellent excuse for this inertia. Still, compared to the mega-stimulus during the COVID crisis, the current situation is tighter, as this IMF deficit graph for advanced economies shows.
If the economic news flow is bad, i.e., it points to a contraction in economic activity, it reinforces the risk of an incipient recession. So far, the economic data has been better than expected, but still many indicators, from manufacturing to consumption, point to at least a cooling of the global economy after the frenzy. As I pointed out in my last post, the meltdown of the world's largest asset class, real estate, can make an unpredictably deep dent in the economy.
Weak data can halt rate hikes, but central banks that have burned their fingers with inflation may not be too keen to immediately launch biting market support measures, as was the case in 2020. They are vividly aware of the monetary policy mistakes of the 1970s, when rampant inflation spiraled out of control again and again as central banks loosened their grip. Moreover, bottlenecks such as underinvestment in the energy sector and a tight labor market may now be encountered more quickly as the economy recovers. It’s worth noting that the Bloomberg indicator of monetary tightness in the US turned positive in recent weeks, making it harder for the Federal Reserve to fight inflation.
However, too strong economic data, such as employment data in the US, fuels inflation, forcing central banks to continue tightening. Generally speaking, buying shares at full employment hasn’t been the best idea, but this time it may be different. So things are an investor's tip, a model of the mud.
So from an investor's point of view, things are topsy-turvy. It's too hot and sweaty when you're skiing, but as soon as you stop it gets cold. And the economy would have to come to a virtual standstill to reverse inflation.
A recession isn’t always a disaster for shares. It may well be that the market bottomed out in the fall to anticipate that the economy would cool down in good order and then continue to grow at a brisk pace. At the same time, inflation will cool as bottlenecks are resolved, and interest rates will fall. In my view, this so-called soft landing scenario has improved its odds in the light of recent data, and in many brutalized sectors such as technology the investor will be handsomely rewarded if it materializes. But the road we have to walk there is winding.
Still, at least for my taste, this hugger-mugger market I describe best illustrates the stock market from an investor's point of view. Things could turn out for the best, but at the same time most of both good and bad news is a headwind for equities. Amid the recent green colors in the stock market, this is a risk worth bearing in mind.
One way for the stock market to strengthen its resistance to this development would be to fall, and at some point valuation levels would reflect this pressure. I'm not quite sure if the current level is quite there yet, with many companies hovering at all-time highs and indices having recovered nicely from the autumn lows.
It would be interesting to hear your thoughts on the current market and what you think about this faltering market. I'd be happy to hear your thoughts on Inderes Investment Forum.
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