The tepid and soporific Goldilocks leaves. The little girl with the golden locks, who for eight years rejected the two cups of inflation too hot and inflation too cold and continued to prefer the saucer of mediocre growth to that of stagnation and the hypercaloric one of the boom, it was actually sent home by the voters of the West. These voters, who had endured the first grim years following the 2008 crisis with great patience, eventually got tired of waiting and started demanding less lectures on secular stagnation and austerity and more growth.
That is, they endured bloodletting and purges in the name of austerity when they should have been demanding tonics and energizers and began to raise their voices and rage when in reality things were really starting to get a little better. The social body always reacts with delayed times compared to those detected by the economists' seismographs (politicians stand halfway). He doesn't do it because he's stupid, but because the consequences of the economic cycle hit him after months or years. Orders may begin to drop and the economist immediately understands that the cycle is over, but the factory continues to work as before, slowly accumulating the unsold in the warehouse.
Then, with a full warehouse, it cuts production, but not jobs. And if things continue to get worse, he burns the cash on hand and then asks for a loan from the bank. When even this is no longer sufficient, social safety nets come into action, from unemployment benefits to those sad expedients used in America in the early post-crisis years, from the explosion of disability benefits to the administration of opiate-based drugs to the fired (by both public and private health systems), with the beautiful result of two million new addictions precisely among men of working age, the core of the workforce.
The opposite happens when things improve. Orders begin to grow, but the factory satisfies them by slowly emptying the warehouse. Then yes, production increases, but no one is hired, because the first resort is to overtime, then to temporary staff. Then part of the activity is outsourced, but outsourcing is typically entrusted to precarious personnel. This, even if he works temporarily, does not reach the psychological security that allows him to go into debt to buy a car or a house and, even if he does, it is the bank that does not give him credit because he does not have a stable job.
The next step is the factory's renunciation of collecting additional orders, in the hypothesis that it is a passing phenomenon. If after a few months the demand remains high, we resign ourselves to hiring, but without compromising on the required qualifications. Then you start to compromise, but maybe you still don't find what you are looking for. Eventually you start to offer more and that's when wage inflation starts, especially if productivity doesn't come to the rescue.
Today the world is governed by central banks who are terrified of reliving a recession experience (also because they wouldn't know what to do, especially in Europe, if not completely Japaneseise themselves and monetize public deficits for life) and who, even if they have any intention of normalizing monetary policy, are obliged held back by the new generation of politicians, those elected in recent years with the mandate to grow at all costs.
And if the world wants to grow at all costs, then it will grow at all costs. Having overcome the monetary taboos in the Goldilocks phase, we will happily overcome the fiscal taboos (for now). The republican tax reform, after a year of tiring gestation, injects 150 billion a year into the economy and attracts harsh Democratic criticism for the budget hole it creates. Then what are Democrats and Republicans doing together, behind the scenes and in a few days? They launch a budget for the next two years which causes a further hole of 400 billion, 200 a year, which adds to the other. No one protests, except the usual Rand Paul. Once you learn how to do it, spending becomes easier and easier. Welcome to Adventureland, the land of experiments where you try to see what happens when you try to pour tax gas in a context of full employment.
Growing at all costs, however, precisely means that there are costs. Year-over-year US inflation will be very close to three percent in December. There's a lot of base effect, but it won't look pretty. In recent days it has often been repeated that the rise in bond yields (or the fall in prices) is not due to an expectation of higher inflation but to a request for a higher real rate. Then, after days spent comforting us in this way, data on real inflation arrived, which was also growing strongly. There is therefore a double pressure, on inflation on the one hand and on premiums for term and credit risk on the other. This pressure has realigned bond prices sufficiently downwards for now, but more realignments will happen in the next couple of years if there are no recessions or stock crashes.
The transition from Goldilocks to fireworks involves separating the destinies of bonds from those of equities.
Under Goldilocks both did well, in the new regime equities will do better than bonds. This does not mean, mind you, that equities will necessarily rise because the lowering of multiples due to the rise in interest rates will undo overnight what growing earnings will have woven during the day. Simply put, equities will trend
to rise in the moments in which the bondholder will remain calm, but will then have to go back to retracing in the phases of malaise of the latter.
Adapting this scenario to Europe is complicated. The rise of the euro will curb inflation, which will remain an exclusively German phenomenon (finally the internal revaluation arrives in Germany), but European bond yields will still rise, albeit much less than in America, due to an increase in the global risk premium and the end of ECB purchases in six months . The European stock exchanges, for their part, will have to deal with a strong euro that works against and with lower earnings growth also in America, but they will have the support of less competition from bonds. Overall, we are not among those who continue to favor Europe because it has lower multiples.
Europe will always have lower multiples than America as long as it comes to comparing a European automaker with an American tech or a fragile European bank with a strong American bank. Coming to the short term, the storm of recent days has been reabsorbed and everything has reached at least a temporary level of equilibrium. The correction has caused everyone to be a little more cautious, but it caused no real fear and was overcome too easily. This means that there will be others in the coming months, perhaps less fulminant but still annoying. While waiting for a new episode, the share will continue to recover, but more slowly.
The increase in volatility that can be glimpsed is not that of petty volatility day by day, but that of repricing waves separated by weeks or months from each other. We remain positive on equities, but we think even more than before that to really enjoy what the bull market can still give us, it will be better to keep structurally smaller positions than in previous years.
