Blain’s Morning Porridge 30th June 2023: Half Time Score – how is 2023 likely to shape up for markets?
“Sooner or later we all sit down to a banquet of consequences”
Markets have been far more positive than expected in 2023 – thus far. There is still much uncertainty out there, but what is the market missing? I have two particular under-played threats to watch – corporate debt and social unrest.
This morning I am indebted to a reader for the top-line quote. I think it sums up finance, markets and the vagaries of political economy rather well….
We Scots are a perverse race – just days after the summer solstice I guarantee we’ll be observing how “the nights are fair drawin in” – despite the promise of summer through July and August, we’re already thinking about the short, miserable days of winter fast approaching. Aye, seldom is a Scotsman mistaken for a ray of sunshine….However, on the basis if you expect the worst then you are unlikely to be disappointed, let’s think about what the second half of 2023 has in store.
To predict the future, understand the past. Consequences… consequences.
Despite plenty of doom-mongering after the punch-to-the-face that was 2022, it’s not been a bad year at all – thus far. US Tech Stocks are back in bull territory – it’s pretty much been risk-on across markets. Across the markets the worst markets have merely flatlined. Some, like the UK, may even be perverse opportunities as they look at their nadir. How the remaining half of 2023 pans out really depends on how long confidence in stronger than expected growth, lower than anticipated inflation and strong employment data dominates the headlines.
As an overlay, and setting the tone for H2 2023, I remain convinced the price of all financial assets remain profoundly distorted by the consequences of the QR/Ultra Low interest rate era. At least 60% of the market – anyone below the age of 40 – sincerely believes government/central bank interventions to boost growth or prevent pandemic damage is a natural state of affairs – the new normal. They believe if things get “bad”, central banks will act to make them less so. Therefore, they invest in the expectation “bad” is something that only happened in the past. Thinking bad won’t happen fuels speculation.
That’s my first prediction for H2 – governments are too broke for further fiscal stimulus, and central banks aren’t going to risk further monetary distortions – if things turn bad… they might get really bad. The youngsters who confidently expect bail-outs and supports may be disappointed.
But, even though my base case is the market is overly optimistic about positive momentum, the degree of liquidity available and the trajectory of rates – things may turn out far better than I fear. It takes pragmatic pessimists like myself to keep pricking the bubble and reminding the market we are still not in age of normal – which is normalised positive real interest rates.
The big themes of 2023 thus far have included the following – my expectations are shown in square brackets:
- Inflation – how fast will it come down? [Slower than we hope – inflation will remain sticky due to supply chains, production costs, labour shortages and wage demands.]
- Recession – how likely are national, regional and global recession threats? [Yield curves say recession. Some nations will see recovery or shallow recession – US. Europe is in more trouble. Stagflation in the UK – despite current 0.1% growth.]
- Tech Investment – how much more will AI fuel tech stocks, and can stock gains remain so restricted to the Tech behemoths? [How sustainable is this in face of rising rates and the overly-hyped bubblicious expectations for AI? Companies with strong fundamentals will remain strong.]
- Housing – how vulnerable are housing markets to higher interest rates and lower discretionary spending? [Slowdown is nailed on. Housing markets depend on demand and supply – the shortage of supply in UK will ensure a shallower fall than feared – which will support confidence, but remind everyone how unaffordable the market is. Housing policy is a key political issue.]
- Consumption – how are falling real incomes, higher mortgages, taxes, and inflation going to change consumer spending habits? [The consumption time-bomb has not yet gone off – consumers are still in post-covid, party-now mode – when debt overwhelms them, it will crush spending.]
- Global Trade Reset – how will the west transition to “secure” supply chains, and what effect will it have on the China, and Indian economies? [China now longer drives the global economy, and its increasingly clear it relies on it. As the West diverges for “strategic” reasons, India could be the main long-term beneficiary – aided by demographics.)
- Geopolitics – how will international relationships between the West, formerly aligned nations, BRICS, the South develop, and what threat levels will they result in? [I am very positive the geopolitical threat is lessening – Russia has been humiliated, China understands the need for reproachment with the West, and the Gulf is seeking rentier returns – it all favours less torrid geopolitical volatility.]
- Sovereign Debt – how vulnerable are economies to their outstanding debt and what does it mean for future growth? [The UK is a case in point – it’s Virtuous Sovereign Trinity of stable currency, sustainable bond market and political competency looks under pressure as the market worries about 100% Debt/GDP, Sterling and what the weakened government can do to make the UK look attractive.]
What’s missing from that list? What are the things the market isn’t worrying about …. Yet?
I have two major threats ahead – which may become big themes for the rest of this year.
The first is Corporate Debt. The imminent meltdown of Thames Water – which I wrote about yesterday – highlights how highly levered corporates will struggle with higher rates. Bankruptcy practices are getting busy again. Default rates are rising. If we see a substantial number of “big-ticket” defaults across the corporate bond universe, its bound to impact confidence across markets, raising “domino” event probabilities, and the possibility of contagion as banks start to pull credit lines and access to capital. The possibility of a debt crisis is a medium level threat – and one to keep a close eye upon.
It’s a self-fulfilling crisis – as banks and investors start to fear rising defaults, they hike credit spreads making refinancing conditions tighter – accelerating the crisis for corporates seeking to refinance. It’s happening already as new issue markets become more difficult.
The second threat is more nebulous – Social Unrest brought about by a host of factors: inequality of earnings and opportunities, climate change, rising unemployment, inflation, wages, and populist politics. The bottom line is when people feel unhappy and are gathered in unhappy groups when someone shouts riot – then they usually do.
The French are revolting – I can never resist using that line. The French are different – they will burn police cars over a parking ticket, but there is clearly a massive groundswell of resentment and a sense of unfairness driving the current riots over France. We can all ask why a young man driving down a bus-lane tried to avoid police questions, and what that says about respect for the police – but shooting him dead was…. a lit match thrown into a box of dynamite.
In the coming months we are going to see further crises points emerge across the West. In the UK crashing incomes, stagflation and a sense of busted country and a whiff of bad government could trigger unrest. In the US political polarisation between the return of Trump and questions about Biden is likely to trigger more anti-woke sentiment – and potential flashpoints. In Europe, the old issues of illegal immigration and youth opportunities and employment could well come to the fore. All these crisis points raise risks of political populists – and they will be fuelled by Russian (and probably Chinese) fake-news interventions in the hope of destabilising the West.
The bottom line – be aware and let’s see what H2 brings.
Five Things to Read This Morning:
WSJ Markets’ Monster 2023 Rally Defied All Expectations
BBerg UK Living Standards Resume Decline in Fresh Blow to Sunak
FT FTSE 100 falls Flat as UK misses global stock rally
Guardian Macron Convenes Crisis Meeting
Times UK grows 0.1% – avoiding recession
Out of time, have a great weekend, and back to the day job.
Bill Blain
Strategist – Shard Capital
I already said that “the nights are drawin’ in”, two days ago when I went to switch the hall light on about 9 o’clock in the evening ! And I wasn’t trying to be funny, it just came out naturally.