It's been a while since the last post. Why?
Because I'm not a big fan of trading in a downtrend and I rarely make any transactions in such an environment. Although I plan to write about some notable achievements: the S&P500 has grown by 25% and Nasdaq by 45% !!
I want to say that this is a strong impulse that indicates that the market has recovered, and the worst is behind us, at least for a while.
So, do the economic indicators show the same picture?
Let's start with the most current one - inflation. The inflation experienced the fastest rise since the 1980s. This time this rise of inflation was affected by the rapid price increase of energy resources, in connection with global events. The price of oil reached the USD 120 mark, which had happened only once before - in 2008. The price of gas in Europe experienced unprecedented peaks as well. As a result the inflation just took off.
Of course, this triggered a sharp reaction from the monetary policymakers, and now the whole world is experiencing a rapid rise in interest rates.
Currently, the interest rate in the US is 5.5%, and 4.25% in Europe. And another increase of 0.25% is expected already in this year. The "ease" of interest rates is expected only when the inflation indicators normalize, and the labor market stabilizes. The forecasts, however, are quite controversial. Some claim that interest rates will start to decline only in 2024, and some are rather certain that interest rates will go down already this year. Time will tell.
High-interest rates have affected everyone. Current credit interest rates are continuing to increase. So, no wonder folks are reluctant to take on new credit obligations. All this led to weak GDP results.
Early in 2022, the US experienced two negative quarters of GDP growth, which goes hand in hand with both high inflation and the war started by Russia in Ukraine...
The world had just started to recover from the effects of COVID and was preparing for a stable period of growth until Putin thought it was the right time to start a war, revealing the true face of Russia to the whole world. Only very naïve can believe that Russia’s appetite will be fed by some parts of Ukraine. Despite sober warnings from Baltic states and Poland, countries that are very well informed of Russia’s policies and attitudes, some bribed or foolish politicians are trying to convince the rest to seek negotiations with the Putin regime now. Are you serious?
There’s no going back! What additional proof do you need to get if Finland and Sweden broke their oath and joined NATO at the earliest possibility? These are rather pragmatic states without illusions about what’s going on.
If during COVID times we experienced changes in supply chains, the current War intensifies everything. The global political situation is changing, commodity markets are changing, supply chains continue to evolve, and the economy is struggling with the consequences. This is clearly visible in Europe. GDP growth is close to none, and Europe's "producer" and economic driving force Germany has been in recession for several quarters now.
Here's Europe’s GDP growth:
And here’s Germany’s GDP growth:
And here comes rapidly growing inflation in Europe, as "icing on the cake":
Of course, we can’t omit the inflation increase in the USA as well:
The 10-year and two-year Treasury yield spreads sum up all this very nicely. This is deep in negative territory. Please note that since 1978, every time (with 100% accuracy!!!) when the "spread" has been negative - it was followed by a recession. How come this time will be different??
And another long-term graph for this "Spread" with highlighted recession periods in gray. It’s perfectly clear that a negative period always was followed by a recession. It doesn’t matter how long and deep as long we acknowledge this fact itself.
Another proof-point: manufacturing indicators are way below 50.
In general, the European and US production indicators are in sync, showing a stable correlation. In blue - the US production index and in orange for Europe. They correlate nicely both in the short term and in the long term.
Whenever both manufacturing indexes in US and Europe show poor results, the recession follows. Although, it must be said right away that the "bare" manufacturing index is not the ultimate indicator of the economy. You should take in other indicators as well, taking a thorough look at everything. But the fact remains – manufacturers sense all these consequences more than anybody: inflation, commodities price increase, and the impact of the war. And historically, when European producers "bleed", the economy also bleeds. Below is the graph – the European production index with marked periods of recession. Needless to say, the correlation is obvious.
And, as we well know, the European and American economies go hand in hand. If things go badly on one coast, it also affects the opposite coast.
Now, seeing all this, one might want to know – when realistically will the interest rates be reduced? For how long the market will endure the high rates? To answer this, you need to understand what is happening with inflation. In order to understand inflation, one must look at the prices of energy and commodities.
As we can see, gas prices have fallen by 80% within a year period. This is particularly important for Europe. However, a lot will depend on how cold the upcoming winter will be. Energy resource prices also directly affect electricity prices in Europe. And along with the drop in gas prices, electricity prices also fall:
Additionally, let’s look at another hot topic: grain prices.
As we can see in the inflation indicators, food prices have risen very rapidly. In Europe + 13%. However, grain prices have stabilized lately for quite some time.
Yes, at the beginning of the war, prices flew into space. Now prices have somehow found solid ground.
Yes, Russia's position in the grain deal can change quite a lot.
But, if you think straight, it’s rather simple with Russia, they won’t miss any opportunity to mess up everything they can get their hands on.
And now we return to the initial question – when can we expect the stabilization and reduction of interest rates? Inflation, as we can see, is already decreasing. And falling commodity prices also indicate that inflation is expected to continue to decline. However, there might be some changes that could alter that course: war, cold winter, and OPEC decisions (e.g. drastically reducing production volumes). Therefore, under the existing conditions, if no overseen factor will come to play, inflation will continue to reduce.
And, if we look historically at the FOMC and its decisions to cut rates, it usually happens when either a recession was approaching or there is already a recession.
And here I would like to agree with the most aggressive forecasters that the relatively high-interest rates will not be able to last for a long time. Why relatively? Because historically the market is used to long-term cheap money, and it has become the norm. And, since the outlook of several indicators tells us that the economy is not in a good state, the inflation most likely will continue to decrease, and may even experience rapid fall.
Expect a slight economic ease and, as a result, a correction in the financial markets. Looking at both the SP500 and FAANG charts separately, it also looks like a correction is expected from a technical point of view.
Why am I specifically referring to FAANG?
Simply because FAANG (Facebook, Amazon, Apple, Netflix, and Google) makes up 20% of the entire S&P500 index. Therefore, it is safe to say that if the FAANG adjusts, the index itself will adjust as well.
So, my point of view: I want a correction - BIG or SMALL, it doesn't really matter. And I am ready to think that the economy will be back on track and a new cycle will begin.