Macro Crosscurrents

It’s an exciting time in financial markets.  According to many respected macro observers, there’s a sense that we’re on the cusp of change… a shift in “what’s working”… potentially a profound shift…

It needs to be acknowledged just how uncertain the general outlook is at the moment.  It’s been an amazing few years.  And think about all the things that were “going” to happen”: 

The post-Covid bout of inflation would quickly subside… interest rates would stay low for the foreseeable future… if interest rates did rise, the stock market would tank because the main reason it kept rising was “TINA” (there was no alternative place to get any return)…

Then in 2022 it was a certainty that Fed interest rate rises would help precipitate a recession… then inflation began easing without a recession fuelling optimism that the worst was behind us and we were on the cusp of an economy-positive, stocks-positive cutting cycle…

As this year began there was an expectation for 6 Fed interest rate cuts in 2024, fuelled by declining inflation… if interest rates didn’t fall in 2024 the stock market would tank because the main reason it kept rising was optimism about rate cuts…

Phew… it’s been a tough few years…

Throughout it all, one of our main messages has been “it’s a time to be very cautious”.  That remains the case.  But that doesn’t mean “do nothing”.  Whilst nobody knows with any certainty what the future holds, there are some interesting ideas circling… some suggestions of how things might profoundly shift.  If these ideas prove prescient, now is the time to make some bold capital allocation decisions.

Today, we’re going to take a brief look at some of the key macro themes circling the globe (and our thoughts).

U.S. Stock Over-valuation:

Of course, if you’ve been following our commentary for the last few years, you know this one has been a key focus for us.

It needs to be understood that within the macro investment community, there’s no question that US stocks are very over-valued from a historical perspective.  It’s a simple fact. 

Of course, that doesn’t mean that US stocks are about to crash 40% lower.  Once again, what happens next is highly uncertain.  But there’s no questioning the fact that US stocks are currently very over-valued.

China

What can we say about China?  We’ve covered the story at length many times over the past decade:

A centrally-planned Communist country that created an economic growth model focused on several areas.

They became “the world’s factory” by (cough) “cheating” on global trade, suppressing their currency via a closed capital account and putting their huge population to work in factories…

… whilst also embarking on an epic national build-out of infrastructure including cities, factories, railways…

… which morphed into an epic residential property bubble… that has now seemingly popped…

China’s current focus is to double-down on exports.  But they have already claimed an incredible percentage of global tradeable goods – their trade surplus is several percent of global GDP.

Given the weakness in their economy, their share market has really been struggling.  Smart commentators point out that valuations are very compelling.  But the big question is where the economy goes from here.

Their faltering economy poses some real risks globally.  Sydney-based hedge fund manager recently had the following to say:

Sorry John, I’m as lost as you…

“Real” Assets versus “financial assets”:

Just in case you haven’t been paying attention, “financial assets” such as shares have been all the rage in recent years.  Venture capitalists have been eager to fund every new fintech, food delivery, “AI” and whatever else they see has a good chance of being hyped up by investors so they can hopefully make billions when the (unprofitable) business IPO’s on the NASDAQ.

Capitalism at work, I suppose.  Really no different to what we’re trying to do with our investment activities.

But there’s been losers in this. 

The world needs basic materials as much as ever.  Copper, oil, iron ore, natural gas, lithium…

But for the most part, investment in these sectors has been shunned:

Some smart investors believe we’re on the cusp of a secular turning point – a point where the lack of investment in resources production manifests into supply constraints, fuelling rising prices… and, most significantly, fuelling interest from investors/speculators.

In the simplest sense, the thesis is that (extremely overvalued) “financial assets” are ready to “stop working” for the first time in 15 years and resources are going to “start working”.

It’s a compelling thesis.

But, circling back to John Hempton’s comments, I think an awful lot of this hinges on China.  They have been a huge consumer of natural resources.

Perhaps we’re just a little too early for this theme.

US Debt:

This is perhaps the big one.  Over the past 20 years, a budget deficit has become an entrenched feature of the American economy. 

As I’ve alluded to previously, this to a large degree is a “balancing” of the significant trade deficit the US has also been running – particularly with China.

But the numbers are getting huge.  US government debt is now around 124% of GDP.  As many have commented, the interest cost on the outstanding debt is now a significant expenditure item for the US government.

Veteran economics commentator John Mauldin has written extensively about the issue over the past year.  As he sees it, there’s no way out now – a crisis is coming.  As he explains, there’s now no way to balance the budget – the spending cuts required are too big and there’s no chance of raising taxes in any meaningful way.  It’s political gridlock in Washington and no appetite by anyone to really address this.

Note that he’s not suggesting this is a problem for today.  Just one of these slow-motion train wrecks we will learn to live with.

He’s certainly not alone in his concerns.  A number of smart commentators are saying the Fed needs to bring interest rates down simply to make the interest bill “affordable”.  Simultaneously, others such as the esteemed fixed-interest investors at Oaktree Capital have politely expressed concerns about the level of bond issuance needed and what happens to interest rates.  Of course, they wonder whether rates are pressured higher regardless of what the Fed does – a nasty proposition if it happens to any real degree as it implies the Fed has lost control of interest rates.

It’s going to be fascinating to watch this play out.  As I’ve frequently highlighted, it needs to be remembered that a country with its own floating fiat country is not a household and not under the same rules of economics as you and I. 

This has powerful implications for the US dollar, which of course has powerful implications for global currencies including the Aussie dollar.  Macro cross-currents indeed…

There’s no doubt that shares – in a broad sense – will continue to provide compelling returns over the long term.  Its simple maths – over time, corporate profits reliably grow in-line with economic growth and as earnings grow the “value” of the shares increases.

But starting point matters a lot.  What’s “worked” for over 15 year now was simply owning shares – particularly US shares.  I strongly suspect that from this point, the next 15 years will be a bit different.  It’s probable that other asset classes and smaller niches of the share market will perform better than the market itself.  Our goal is to do our best to navigate these treacherous waters and do what we aspire to do – make some sensible decisions based on a deep understanding of financial history.