Confusing Markets: be confident when others are fearful…

Blain’s Morning Porridge, August 8 2022 – Confusing Markets: be confident when others are fearful…

“We’re on the road to nowhere…”

This morning: So many contradictions abound in current markets, but it’s possible to cut through the noise to discern some probable direction. The old adage of being confident while others are fearful looks one way to approach the current confusion.

Oh! What a confusing picture it all looks – but underlying the maddening swirl of events, there is usually some method, rhyme and reason.

• As we prepare for another heat-wave, the reservoirs are empty, hose-pipe bans have been imposed, and The Bank of England is telling us a tale of imminent doom and destruction – 13% inflation and a deep recession heading our way.
• The ECB is blithely ignoring the rules and spending the cash from maturing bonds to stabilise the wobbly Italian market – cutting its risk on Germany and other prosperous Northern European sovereign credits, to load up on Southern European Risk. What can possibly go wrong as Europe heads towards a cold winter without any gas?
• Central Banks around the globe are accused of getting it utterly wrong with their expectations and planning for “mild transitory inflation”. Policy mistakes are responsible for six out of every three recessions!
• There are dark political utterances and noises off about reviewing the independence of Central Banks – politicians looking to squarely and unfairly shift the blame on to the CB gnomes for the multiple policy mistakes and compromises that have apparently got us to here.
• US non-farms payroll employment data shows a US economy at full tilt – double the number of new jobs the Fed Watchers expected. (What matters is the participation rate – in the US that’s close to the average of the past 40 years – around 62%.)
• Weekend snooze papers write about the Great Resignation and how millions of employees “working from home” are basically doing the bare minimum to keep their paychecks rolling in.
• Stock markets had a smashing July and look to be thwacking the leather off the ball in August, contrary to every indication of rising rates, rising inflation and rising tension.
• Nancy Pelosi’s proved herself the Girl Who Kicked the Hornet’s Nest, upping the geopolitical tension between China and the US.
• Bond markets are all over the shop….
• And, to top it all, Donald Trump looks ahead of the game as the Republican contender in 2024. `

What to make of it all? If markets made sense… where would the fun be in that..?

Europe vs US

I’ve commented a couple of times on how the US looks a better bet for recovery than Europe. The US is a largely self-contained economy with a single unified currency – so is Europe. Why will one succeed while the other is likely to experience a deep and painful recession? King dollar is one reason, but non-aligned economies and energy insecurity define the other. It’s the main reason the smart money continues to follow the dollar.

Yet, Europe may yet surprise us. Despite the difficulties obtaining Russian gas, reserves are being built up across the continent. The ECB apparently faces enormous problems stopping a full blow Italian debt crisis – but they have done it before, and can do it again!

Geopolitics

Let’s move on the geopolitical threat. I wonder if we overestimate the current tension? Last week’s market narrative revolved all around Pelosi’s trip. The fear was how she could trigger a Chinese invasion of Taiwan in a devasting show of strength and military power. Just like Russia was going to do in Ukraine? ……

Whatever the armchair generals think, its less likely than the market fears. The Red Army and the People’s Army share similar tactical doctrines – which have been exposed in Ukraine as hopeless in the face of motivated opposition. Taiwan is a far more difficult target, requiring a full sea-borne invasion, rather than the direct roads that led to Kyiv. Taiwan is very well armed. Ukraine was not. Economically, we assume the Soviets Russians have unlimited resources to fight a war, but the reality is they are struggling to keep units functional as the economy wobbles under sanctions.

China’s economy may be stronger than Russia’s but their forces are wholly untested. In the wake of the pandemic China is hardly at the full pelt it would need to be to fight even a short, sharp war to recover Taiwan. A number of commentators make the point China is sanctioning Taiwan food exports, but remains desperate for its electronics and semiconductors. (Very good outline of this on John Authers this morning.)

There is another view of Pelosi’s visit. While in Taipei she met with TSMC, Taiwan’s dominant chip maker. The US is as dependent on chips as China. The defence of Taiwan and semiconductor security is a strategic imperative for US security – which is why Pelosi would have been urging them to shift production to the US. Taiwan would be daft to do so – their Semi-conductor dominance ensures tacit US support if the Chinese were to get antsy.

The reality is stalemate. China can bluff and bluster with wargames and talk loudly about its carrier killer missiles, but it is keen to avoid confrontation turning hot with the West. They appreciate the risks it could turn tougher for longer, thereby embarrassing President Xi as he seeks the Jade Throne in perpetuity.

An Evolving Economy

Back here in the west, its gradually dawning on financial markets just how much the economy is changing following the pandemic. We are moving into a new post pandemic economy – where a massive shift of workers has occurred out of traditional leisure, hospitality and transport/tourism sectors (where the work is hard and generally low paid) into better paid work, less onerous jobs or out of the work force completely – the Great Resignation.

Next time you are in your local pub – just ask how difficult it is to get staff. Practically impossible. Highly skilled, but grossly underpaid chefs found they work fewer hours for more money stacking shelves in Sainsbury. (I know – chatted to one at the weekend!) If local restaurants and cafés raise prices to pay attractive salaries – they quickly lose business. (We won’t be going back to one local eatery after a sharing plate of cheese and carpaccio arrived with a mound of rocket, four tiny cubes of very unimpressive cheese and 6 slices of chorizo and salami set us back over £25.)

Exactly what this new economy looks like is unclear, but there will be gaps to fill – which will offer opportunities to improve productivity via growth stocks focused on automation, robotics and data driven work flow. (I note Goldman is one the wires saying its time to buy growth.) Funnily enough, while I can see how chefs can be substituted and replaced by automated burger and pizza flipping machines, it’s the human element of waiting staff who will be most difficult to replace, but are now in the scarcest supply!

There is an interesting moment for markets coming – as ever it won’t be the complete destruction everyone fears, but a change in the way things work, and what the opportunities may be. Remember my market mantra No6: “Things are never as bad as you fear, but seldom as good as you hope.”

No time for 5 things this morning…

Out of time and back to the day job

Bill Blain

Strategist – Shard Capital