Bear Market Rally

[윤영준]

Financial markets have not exactly gone to plan so far this year. At the beginning of this year, many investors anticipated a strong headwind to risk assets because they believed that corporate earnings would collapse in early 2023 and bring the stock market down with them. However, they have been wrong-footed and 2023 was off to a much better start for risk assets. Worries about recession, overwhelming a few months ago, seem almost forgotten. This was helped by signs of a firming disinflation and the resilient economic data which were inching towards a soft landing narrative in many developed countries. In consequence, the most beaten-down stocks from the last year made an impressive turnaround. For example, cryptocurrencies, non-profitable technology stocks in Ark Innovation ETF and most heavily shorted stocks in MEME ETF all recorded above or close to 30 per cent return year to date. Contrary to a steeply inverted yield curve and interest rate cuts being priced in because a recession is looming, risk assets do not appear to discount such a possibility. It feels like that the recession bet simply went awry.

However, January non-farm payroll data came as a big surprise, which show that more than half a million jobs were created. At the same time, the latest report of persistent inflation is likely to enforce the Fed to maintain its hiking cycle a bit longer before it pivots. The big risk to markets this year is not necessarily a recession but a labour market that remains robust. The labour market matters because central banks put the pressure on higher demand from strong wage growth at the centre of their battle again inflation. Although average hourly earnings continue to decline a little, tight labour market condition is unlikely to dissipate soon. Investors are now concerned that the Fed may keep raising interest rates until June and its target rate could be revised upward in the next FOMC meeting. Outside of the US, European economy proves to be more resilient than previously expected partly owing to a plunge in natural gas prices, and the reopening of China from the zero-Covid policy certainly boosts the global economic growth. As global trade is driven more by national security, supply chain resilience and sustainability instead of cost and efficiency, this will in turn sustain inflation at an elevated level.

In order to foretell the direction of inflation and speed of its changes, we need to understand the causes of the current high inflation. In a combat with the pandemic, the US government deployed massive fiscal stimulus packages equivalent to 27% of GDP in 2020 and 2021. With lockdowns and limited access to outdoor activities, consumers splurged on goods. The surge in demand clogged the already strained global supply chains, which exacerbated production delays and shortage of inputs. Then, it spilled over to the rest of the world and inflation broadened to services, wages and rents as economies reopened. Although goods inflation has fallen significantly with the normalization of supply-chain bottlenecks, service inflation is still rising. On the other hand, labour markets remain tight in many developed economies due to the imbalance between demand and supply. Since the breakout of the pandemic, labour market mismatch has been intensified and there was an exodus of early retirement. As a result, the ratio of vacancies to unemployment has risen and the pressure on wage has accelerated. Finally, energy prices soared due to the Russian invasion of Ukraine and recovering demand although prices substantially dropped from their peaks.

Origin of the current inflation

Moreover, measures of the sentiment from the recent data are throwing off so many conflicting signals. GDP growth in the last quarter of 2022 turns out better than expected, but PMI indices indicate that the global economy is shrinking. A tight labour market and elevated inflation are certainly an argument for keeping interest rate higher for longer. Given the mixed message from the data, the investment community is currently divided between the soft- and hard-landing debate. We can define a soft landing in which heat can be taken out of the economy without causing it to veer into a recession. It has a significant implication for investment strategies because performance across asset classes will greatly diverge depending on what kind of landing is ahead for the economy. The chance of a soft landing comes down to how quickly inflation falls. No one really has any idea what will happen, in large part because of the mass transition from goods spending to service spending in the aftermath of Covid. The cooling inflation reports that markets had cheered on lately have all come on the back of goods inflation. Is today’s services inflation just a temporary Covid distortion working its way through the economy? Is it a more entrenched expression‎ of the labour shortage? Or as the full force of the super-aggressive monetary tightening in 2022 finally gains its traction, will the real economy slow down significantly and inflation decelerate more rapidly?

	Soft Landing	Hard Landing
Inflation	Gradually decelerates	Persistent at an elevated level
Labour Market	Unemployment remains steady	Unemployment eventually rises
Corporates	Earnings moderate, not collapse	Profits down, more cuts in investment
Fed	Policy rates reaches their terminal rates soon and pivots to cut afterwards	Hawkish stance is maintained for a foreseeable fu-ture to dampen demand
Sentiment	More optimistic	Demand weakens and confidence down
Assets	Risk assets outperform and the dollar weakens	Treasury bonds are favoured and the dollar streng-thens

What’s happening so far this year is another bear market rally? Or have investors been forced to abandon their fundamental discipline in fear of missing out (FOMO)? After missing the rally since October, many investors may feel that they cannot afford to miss another upside. Some investors appear to see a new bull market underway, based on an optimistic scenario in which the Fed successfully tames inflation with only modest slowing in economic growth, corporate earnings and employment. In a zero or negative interest rate environment, markets were driven by FOMO or TINA (there is no alternative to equities), where fundamentals simply were not a part of the investment decision. Can the turnaround in 2023 reignite risk appetite? It all depends on when the recession occurs if it happens at all.

We believe that recent equity gains are merely another bear market bounce, not the beginning of a sustainable bull market. The current rally seems to be based not on improving economic fundamentals but on easing financial conditions. There are many signs opposite to the recent equity market rally.  Treasury yield curves remain deeply inverted, a time-tested signal that an economic downturn is on the horizon. Gold also continues to outperform both the S&P 500 and the Nasdaq. This is curious given that many investors view gold as a safe haven when turbulence looms. If equity investors are expecting a soft landing and potential rebound in economic growth later in 2023, oil prices do not reflect that. Crude oil futures, for example, are down 8.6% year-to-date and 18.7% from a year earlier. We remain cautious about the direction of the equities market in the near term, as these other assets do not confirm‎ the optimistic outlook implied by equities’ performance this year. For a soft landing outlook held by equity investors to be validated, we would need to see steeper yield curves, weaker gold prices and stronger performance in energy sector.

The global economy currently faces a tough couple of quarters, which does not seem to be fully discounted in financial markets. Flipping in capital markets reflects investors’ uneasiness towards the direction of the economy. When the Fed attacks inflation, it can either achieve a soft landing or force a recession. History shows that soft landings are rare, which occurred only in 1984 and 1995 in the previous hiking cycles, and hard landings more likely. In the early days, hard landings look a lot like soft ones. Both feature interest rate rises, followed by a pivot as the market prices in future cuts, and equities begin to rally. For the soft landings, this is the end of the story. But for the hard ones, things start to go wrong; employment weakens, along with housing and investors take a battering. In the past, soft landings were preceded by relatively low inflation and accompanied by loose bank-lending standards. Today’s circumstances are the exact opposite. Even if a soft landing took place in developed economies, the relatively optimistic valuation in financial markets suggests that there would be limited upside for risk assets. On the other hand, fixed income assets are offering the most attractive income and total return potential in more than a decade. Instead of TINA, we now have TARA (there are reasonable alternatives). Uncertainty warrants diversification and caution, and taking an aggressive position in risk assets may be a premature idea for investors in the current environment.

[좋은세상]

다녀갑니다.

[좋은세상]

오늘 광주 왔습니다.