Blain’s Morning Porridge – April 20^th 2023: Business Cycles, Markets, Inequality and Social Threat

“History repeats itself, first as tragedy, second as farce..”

This morning: Markets are thriving, but the news tone is miserable.. how does that happen? Markets aren’t pricing in a rising tide of political friction, plus rising inequality of wealth and opportunity – but these things ultimately matter.

It’s a dangerous thing reading the papers or watching the TV. The news gets more  depressing every day, constantly reminding us how much is broken, unfair and unjust on an infinite tape of rising human misery. The big question is – can all these multiple issues be fixed? You have to hope so… If not I suspect many of us would just give up and go “prepper” on a deserted Scottish Island. This morning I find myself seriously thinking about it… (Note to self: Grip! Get some perspective Bill…! Get a Grip!)

Yet, despite the doom and gloom, a chum just pointed out many global stock markets are either at, or frighteningly close to all time highs. I’ve never really been able to reconcile how my wallet is empty, but stocks markets are booming?

One of my key mantras is “Things are never as bad as we fear, though seldom as good as we hope..’ But is that always true..? Maybe we are headed for a dreadful 3-Sigma Event – where we’ve been betting on Red and but it comes out Black every time..? It’s always a possibility..

I’m trying to figure out timing on a very simple trade idea. Despite the fear and angst about banks – and their vulnerability to rates and recession threats – I reckon most are going to be money good on the basis of national champions, their importance processing cash and oiling the financial wheels of the global economy, and which will remain solvent in crisis. The March mini-crisis has passed, but I reckon there is more pain to come, which should see bank spreads widen, (they are currently implausibly tight for the risks), offering a better buying opportunity.

It’s a classic bear market trade – waiting for a market decline, and trying to bottom fish the deepest part of the cycle. One thing that intrigues me is rising credit default swap prices… my time is perhaps coming….

When will the moment come?……. might be sooner than I think…

Looking for clues, I was reading a very interesting thought-piece from Ray Dalio (wearing his Bridgewater hat), and was struck by his core premises on why markets are in trouble. He identified the following crisis factors:

• Debt – the consequences of ultra-low rates, QE and monetary creation.
• Populism – the increasing polarisation of politics and populism fuelled by rising inequality plus wealth and value gaps.
• Geopolitical change and conflict.
• Acts of nature – drought, flood, pandemic and climate change.
• The long-term pace of Tech change – industrial revolutions, computing, internet and now AI

Dalio is not all doom and gloom, but these forces inter-react. He overlays these factors on top of the long-term historical growth cycle (50-70 years) and short-term business cycles, puts them all together and predicts we’re in for a longer period of tight money to fight inflation, just as we enter an economic contraction phase. I can’t do his full comments justice in my 6-minute Morning Porridge, but they are well worth a read.

One of his key comments is how the political cycle tends to move closely in synch with the short-term credit/debt/market/economic cycle. We know the market financial/economic outlook is looking weak (the threat of recession), while we have a political cycle moving into the 2024 US and Taiwan (plus I would add a contentious UK) elections to factor in. We will have potential economic weakness combined with increased political turbulence. I would add in the destabilisation and potential shock we may see around a failed US debt ceiling crisis, even leading to a technical US default.. which would really roil markets.

Yet, pick up any piece of “market-research”. There will be multiple predictions of growth, renewed equity upside, and the attractions of bonds. But increasingly find myself wondering – “don’t these guys understand why we are here?”

I know I am repeating myself, but I can’t help but wonder how the market is still missing the fundamental reality of the consequences of easy credit and money from 2009-2022. Ultra-low interest rates, and QE, resulted in massive financial asset inflation from soaring stock markets fuelled by easy money and monetary creation. All that credit didn’t flow into the economy – but was extracted via dividends, stock buybacks and upside in to the pockets of owners.

Despite ultra-low rates we didn’t see a golden age of infrastructure build-out, new jobs, productivity gains (UK productivity has flatlined since 2010), or improved public services. The potholes are worse than ever, and health services cost more and deliver less. Markets rose 280% while the economy grew 40% (S&P 500 and USA), but who but a few actually felt any richer?

One of the factors Dalio recognises in his analysis is: “Big conflicts within countries (now most importantly the US) prompted by the largest wealth and values gaps in our lifetimes, which are leading to the emergence of populists of the left and the right who are fighting with each other.”

Wealth inequality is a topic that gets a lot of attention and focus on university campuses, but for some reason (hmm, let me wonder why), is seldom addressed in the presentations of bankers and analysts to their UHNW (Ultra-High-Net-Worth) Family Offices and Hedge Funds. Despite S (for Social) being a key component of ESG, I’ve never been to an ESG conference that featured income and wealth inequality stemming from markets as a core topic. Its ok to talk about building hospitals in Africa, but to address the inequality between workers and bosses back home would be career suicide.

Yesterday’s headlines about UK Food inflation at 19%, while London Rentals have risen 20% plus are shocking – should be a wake up moment. We were told inflation was falling. Nope. Instead, Chancellor Jeremy Hunt tell us the only way to be fair to “hard-working” consumers to stem damaging cost of living increases is to pay them less, stem their earnings and keep pay demands low. The problem is the Chancellor is a Victorian economic illiterate.

This morning, I read about the likely “insatiable Middle East demand” for a £75 mm country house “good enough to be a royal palace” close to London. I didn’t come across anything much to solve the escalating accommodation supply crisis in London housing which is pushing up rents even as banks cut mortgage credit, trapping renters and threatening to price out any and all workers who actually make the economy work.

Or, maybe I’m depressed from reading on Bloomberg about US consumers in crisis taking institutional loan-shark payday lending to pay their grocery bills. Or maybe it was the interview with a furious business-owner berating feckless workers not taking the highly paid Repo-men jobs he’s offering to seize these same consumers defaulted cars.

The bottom line is the Wealthy remain Wealthier than ever. 13 years of easy money made them richer as stock prices soared. Meanwhile, worker earnings flat lined, and a now being dramatically cut (in real terms) but stubborn inflation. One of the proposals from the Republicans in the latest set of polarised non-plans to agree a US debt ceiling, thus avoiding a US debt default as early as June, is to cut funding for the IRS to better tax-audit wealthy Americans to ensure they pay their taxes.

A wise German once said: “Accumulation of wealth at one pole is at the same time accumulation of misery, toil, ignorance, brutality, mental degradation, at the opposite pole.”

The hope is letting the rich remain rich (while slitting the throats of the workers) will encourage trickle down growth. Letting the rich remain rich so they throw crumbs to the poor people has never worked. Ultimately income inequality destabilises economies as revolution becomes more and more likely.

Meanwhile, I’m still waiting for the right moment to buy banks… or maybe I should getting the boat ready for a quick getaway for when the mob takes over?

Five Things To Read This Morning

BBerg              London Rents Soar at Fastest Pace in More Than a Decade

WSJ                 The World’s Richest Person Auditions His Five Children to Run LVMH

Guardian         This isn’t wage-price inflation, its greedflation – and big companies are to blame

FT                    Singapore bondholders prepare to sue Switzerland over Credit Suisse

FT                    Now is the time to buy bank shares

Out of time, and back to the day job..

Bill Blain

Strategist – Shard Capital