Let's try to find an underlying logic in the fuss that has arisen on the markets in the last two weeks and put forward some hypotheses about the future. The six years following the spring of 2009, the low point of the Great Recession, saw the prevalence of linear, long and broad moves in the markets. Rates continued to fall, bonds and stocks to rise. Currencies had two large moves. The first phase, the one in which America adopted the most expansive monetary and fiscal policies, had a substantially stable and weak dollar. In the second, which saw the passage of more expansive policies first to Japan (2012) and then to Europe (2014), the dollar began to strengthen with a constant progression. Raw materials, for their part, also had two linear phases.
The first saw a substantial strengthening, caused by the weak dollar and strong Chinese demand. The second, downward phase was driven by a strong dollar, weakening Chinese demand and the fracking revolution, which led to an explosion in the supply of unconventional oil and gas. At the macroeconomic level too, the trends have been long-lasting and, in their own way, regular. America has had weak but steady growth that has allowed a linear reduction in the unemployment rate. Europe has had a perfectly stagnant France and a Germany which, with its growth, has compensated for the intermittent recessions of the periphery. Global inflation continued to fall slowly, without turning into full-blown deflation. Lastly, on the American stock exchange margins remained constant at record levels, profits continued to grow and multiples gradually expanded. All very smooth and regular. The phase that is opening up, which theoretically could also be long, looks more complicated, nervous and volatile. The navigation for portfolio managers, guided in recent years by majestic and calm currents, will become progressively more difficult. The currents will fragment and cross, confusing, dividing and gradually forming vortices.
Some movements, hitherto linear, will become circular. Let's take three examples, the dollar, rates and oil. The circular movement has already begun on the dollar. With the dollar weakening again, it won't be long before the US economy regains some color and there is talk of a rate hike again. But the idea of a rate hike will make the dollar rise again, weakening the prospects for American growth until we stop talking about a hike or postpone it to a later date. Jeffrey Gundlach talks about a carousel that will keep turning on itself, with the dollar and the rate chasing each other. The same phenomenon, we add, is starting to form on market rates. The dominant line of thought is linear. There was a very long descent and now a long ascent begins. With negative yields, an Alice in Wonderland freak, the physical limit has been reached and the market, seeing that central banks won't decide to raise rates, has seen fit to start raising them on its own.
Central banks, according to the dominant thought, will come later, confirming the market's choice once economic growth has consolidated. Since the growth cycle will be long, the progressive rate hike cycle will also be long. Real yields will perhaps remain at zero, but the price of bonds will go down, down and then down again. This thesis is supported, naturally with different nuances and tones, by authoritative personalities such as Bill Gross and Warren Buffett. Yellen herself, who until yesterday pushed the market to take risks, now admits that long-term yields are abnormally low and expresses concern about the sharp fall in bonds that could occur when the Fed abandons the zero rate policy . All of this is true and right, even if it is bizarre that the market loses patience and sells bonds at a time when global growth is slowing down (with the only exception of Europe). However, there is a basic assumption, that a global reacceleration is starting, which appears correct if we look at the next 6-12 months, but which remains to be proven in the medium to long term.
In the short term, in fact, the American acceleration is practically certain (not difficult, to tell the truth, since we are starting from a first quarter with zero growth), just as it is probable that Europe, after an excellent first quarter, have at least another decent three to six months. Even China, which has moved decisively towards an expansive monetary policy, will see a perhaps surprising recovery in growth in the second half of the year. However, the fragility of the world is structural and structural problems have the bad habit of recurring periodically. Steven Ricchiuto of Mizuho points out that a significant part of the American industrial recovery in recent years has revolved around the automobile, typically purchased on installments. A modest rate hike could bring the sector to a halt. More generally, it must be admitted that the imminent take-off of American structural growth is an urban legend that has been circulating for many years and which has never materialized, nor can we honestly see why it should begin to materialize right now. With productivity at zero growth and population growth much weaker than it used to be, long-term economic growth estimates can only be low. As for Europe, if the current recovery were to translate into interest rates above current levels and a euro in a further significant recovery, the benefits of Quantitative easing would soon disappear and we would return to the starting condition which, we recall, was certainly not exhilarating.
Finally, in China, if the reacceleration is due only to new public works programs and the euphoria of the stock market rise (the government agency Xinhua confirmed that the ongoing consolidation will be short-lived and that the rise will resume), the quality of growth it will always be lower. In practice, therefore, a global hike in market rates would curb growth sooner than we have seen in the past. All it takes is a Fed maneuvering error or a disappointing quarter of growth for market yields to fall as fast as they are rising these days. Another merry-go-round, therefore, between interest rates and growth. Finally oil. In the pre-fracking era, the time from the moment an oil company decided to explore an area, plan production and extract the first drop of crude oil was measured in years (if not decades, as in Kazakhstan). With fracking it is measured in a few weeks. The violent recovery of crude oil in the last two months is due precisely to the speed with which the fracking sector has reduced production. However, it has happened, in recent months, that in addition to production, the cost of extraction has also dropped significantly. So at current prices, it's becoming very profitable to produce again, especially in Texas. Many companies have already announced that if these prices hold, many wells will reopen.
The price, if that were the case, will go back down rapidly. So here, already in motion, is the merry-go-round between prices and production. What to do, then, in wallets? The beauty of circular movements is that they offer the possibility, for those who lose a lap, to wait for the next one. However, waiting is a luxury that only individual investors and long-term investors, such as pension funds, can afford. For all the others circularity, if mistakenly mistaken for linearity, represents a continuous temptation to make mistakes. When in doubt, therefore, it is rational to reduce overall exposure when the opportunity arises. And what to do now? The impression is that the dollar, interest rates and oil have already corrected a lot in recent weeks and that inflation expectations have grown too quickly, just as deflationary expectations had grown too much until some time ago. As for the stock exchanges, the even temporary stabilization of the dollar, rates and oil should be sufficient, Greece permitting, to restore color to the European markets.
