A suddenly hawkish central bank; soaring household bills; a hefty correction in the stock market – and that’s before we even mention geopolitics.
It’s no wonder everyone’s feeling a bit nervy.
So maybe today, it’s time to take a moment to look on the bright side.
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Everyone’s talking about the yield curve again
There are suddenly lots of reasons to be fearful out there: living costs are rocketing, geopolitical tensions are doing the same, and now the Federal Reserve, America’s central bank, has turned all hawkish on us.
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It’s little wonder that some are fretting that the Fed will end up driving us into a recession, rather than simply cooling things off a bit as we head into a recovery.
In particular, we’re suddenly hearing a lot of talk about inverted yield curves again. This is the phenomenon where short-term interest rates end up being higher than long-term ones.
This is the closest thing to a cast-iron recession indicator that we’ve got; it has predicted every recession with no real false positives since World War II. It’s not a tight market-timing indicator as such – the inversion has occurred anything up to two years ahead of time – but it’s very reliable.
It even inverted ahead of the pandemic-driven recession – and yes, your guess is as good as mine as to how the bond market knew the plague was coming, but I’ve learned not to knock a good indicator while it’s still working (this is a joke, to be clear: the odds of a slowdown were probably pretty high I suspect, given China’s crackdown on growth, so I think there’s a good chance the curve would’ve been right this time too, even if Covid hadn’t hit).
Anyway, the yield curve is not yet inverted, but it’s now back in the financial commentary and being watched like a hawk.
Yet despite my often-bearish demeanour, I’m not convinced a recession is something we need to worry about right now.
A recession is by no means a sure thing
The thing is, underlying economic growth is strong: US GDP growth in the final quarter of 2021 came in at an annual rate of 6.9%. Meanwhile, we’ve just heard this morning that the French economy expanded at its fastest rate in 52 years in the same quarter.
So there’s a lot of momentum there. Omicron hasn’t had anywhere near the impact that the worst-case scenarios had implied. And if we’re lucky, it might even be the last major variant that causes any sort of disruption. It’s clear that most countries would rather start thinking about how to live with this rather than stay semi-locked down for good (though watch out for power grabs by governments as “emergency” powers become permanent).
And on top of all that, employment remains high and household balance sheets healthy. Consumers might be worried about heating bills, but they’re still buying iPhones if Apple’s latest results are anything to go by.
What does all this imply? We’re at a transition point, it’s true. Central banks are (for now) actively worried about inflation and they are willing to at least move away from emergency monetary policy settings in an attempt to tackle that.
That has some in the market already worrying that we’ll get a recession any minute. And of course, as noted above, we’ve got soaring energy prices and a genuine cost-of-living squeeze ahead of us.
But at the same time, if you believe the household saving data and the employment data, there’s a certain amount of slack in the system to cover that. That’s not to say it won’t hurt, but it won’t necessarily be a recovery killer either.
As for rising interest rates, unless you think they’ll spike a lot higher – and the jury is very much out on that – then the main effect is going to be on the “financial” economy rather than the “real” one.
Ephemeral companies and “story stocks” and imaginary assets that have been built and boosted on a mixture of distorted discount rates, hype about digital assets, and pure magical thinking, are already bearing the brunt of even the tiny move in interest rates that we’ve seen so far.
But for companies with healthy balance sheets and strong cashflows, the sorts of rate rises we’ve seen so far should be negligible.
This isn’t just about “stuff” versus “tech”, though that’s a big part of it. It’s about genuine businesses and genuine earnings and genuine cashflows being valued again over castles in the sky.
In all, this is probably a good thing. We’ve been living in our heads for too long and it’d probably be a good idea to go out and engage with the world again.
But to translate that into less mushy investment terms, it means that despite its recent run higher, “value” probably has a long way to run versus “growth” (after all, growth has had a much better innings than anyone expected).
Invest accordingly.
