Blain’s Morning Porridge – Feb 8th 2023: The New Normal Economy – What Chance of Getting There?
“If you can use some exotic booze, there’s a bar in far Bombay…”
This Morning: As traders rationalise what Central Bankers say about higher for longer rates, its time to reflect on just why markets and the real economy seem out of line and disconnected. The real issue is about how to reconnect growth and consumption, and that has implications for wages!
Apologies for lack of Morning Porridge yesterday. I woke on Monday morning ready to write something deeply incisive on markets, but got a call telling me to get somewhere else. I managed to book a plane ticket, grabbed a cab to Heathrow, and am now waking up in one of my favourite cities in a Galaxy Far, Far Away.. (well, that’s what it feels like….)
After reading through what I could on the plane, I’m pretty sure markets are getting it badly wrong for the present. When I read that Adam Neumann – the guy we had such fun with while unravelling his disruptive tech paradigm shifting confabulation that proved to be a simple office rental company: WeWork – is launching a new flat rental company as a “elevated community experience”, and some hedge fund thinks its work $350mm… I had to grab another GnT, and then another.
Where does such froth come from?
This morning, let me try to be a little more rational. I don’t believe the world is about to disappear in a puff of economic logic, suddenly understanding just how broken current capitalist economies are. Markets are (probably) not about to experience the most brutal crash and burn of all time… But, But and But again.. there are problems.. and I not convinced markets understand or even recognise them. Which is why I think markets are still mispriced, and we have a correction still to come.
At its most basic “things” are out of whack when it comes to markets and the economy. That’s because we’ve had years of lack-lustre global economic underperformance vs the strongest market upside in centuries. How can that be?
Ask the Central Banks – they know….
After 2022’s correction, markets are focused on what they are hoping Central Banks are going to do – not on what they are saying or doing. Markets think Central Banks care about markets. They do not. The only interest Central Banks have in markets is when they explode, they will explode softly and don’t overly upset the functioning of the economy.
Bitter experience gained over multiple market crashes and threats to the function of economies has taught central banks the economy is a brittle construction – it depends on certainty, growth, consumption and productivity, which basically means making sure companies feel good about investing to ensure workers are paid enough to consume.
Central banks have limited policy levers to pull to ensure such economic confidence – largely confined to trying to control inflation though interest rates. But they are very aware of how economies work – and that it’s the little stuff that changes rational economic behaviours.
Economic growth is complex. It depends on real issues like corporate investment, government infrastructure development, individual’s motivations, productivity growth, education, innovation, mindset etc, etc.. the list is endless. All economic factors that will determine how an economy performs. (Get it wrong – and economies struggle (someone send that to Rishi Sunak please..)
Try and strip it back to its most simple level. It’s largely about the relationship between growth and consumption. While the reality is enormously more complex – it does begin to make a little more sense as you delve into it at the simple level. It’s all about behaviour and consequence. The problem for central banks is its more complex than simply smoothing economies through higher rates to calm inflation – they have an economic crisis of unaligned forces in the economy – a massive imbalance between production (corporates) and consumers (workers). It’s a difficult one to reset because the last 12 years of market froth and high valuations on the back of mispriced money is difficult to reconcile with struggling consumers (aka workers!)
Take the current US earnings season. A mixed picture. Despite US tech companies posting worrying trends, their stocks are generally rising in price because they are sacking workers.. the markets making the simple connection any company that responds quickly to declining margins by cutting costs must be a massive “buy”. The reality is different – who is going to buy their products?
If, as is the case, wages have significantly lagged corporate earnings over the last 15 years, then clearly workers don’t have the same disposable incomes to spend following a spike in inflation. Logic says consumption must fall, as must corporate earnings. Recession? Doh! Corporates earning less, and sacking staff are not going to boost consumption – that requires deflation or a rise in workers earnings – surely?
The reality for Central Banks is they are acutely aware of the consequences of their actions. They started the crisis in 2008 by cutting interest rates to stem the post Lehman collapse. If you make the price of money to cheap – as has been the case since 2008 – then it has consequences: Since the great destabilisation began in 2008 with the collapse of Lehman Brothers and the expectation the global financial system was about to follow it down the dunny, financial markets have been anything but stable. Or sensible.
That’s a consequence of messing with the system. Make money too cheap and it has all kinds of painful consequences. The behaviour of the crowd (the market) has responded to stimuli, resulting in a host of negative effects including:
- Massive Financial Asset Price inflation – caused by investors chasing yields into other financial assets because bonds did not provide sufficient returns. That’s got central banks worried because ultra-low rates have triggered a massive increase in debt – potentially causing economic instability when it needs to be repaid, and crowding-out sovereign borrowing if there is debt uncertainty.
- Underinvestment – companies saw better “returns” from investing in stock buybacks rather than building new plant, factories or investing in new products. The result is wage growth stalled while corporate returns (to the owners of stock) expanded. Consumption reality serious lags earnings expectations.
- Mis-investment – because of ultra low rates many companies mistook growth as a proxy for profits and earnings – hence the sudden rush by Tech companies to “rightsize” themselves as rates normalise. Speculative hype was fuelled by low rates.
Monetarist economists will tell you inflation was inevitable as a result of the explosion in money supply created by QE and Ultra-low rates. Too much liquidity (cheap money), and the inevitable result was inflation.. which needed a trigger.. which was Ukraine and Energy last year, plus supply shocks and Covid the years before. That’s a trend we’ve seen so many times before over history.
Where does this get us?
The UK is experiencing some pretty bleak economic expectations at present, but it is not the only Western Economy in trouble. What’s true for the UK is just better obscured elsewhere. A couple of headlines caught my eye on Bloomberg this morning:
- Luxury Mayfair Homes are Selling at Fastest Rate
- UK May avoid recession but 1-4 Unable to Pay their Bills
On the plane yesterday I was reading how the major fear for the Bank of England is a housing collapse – but how can that be true, if London homes are selling at record prices? The reality is rich foreigners will always pile into London as it perceived to be stable. Meanwhile, the rest of the nation is stagnating, prices are falling, and it feels like we are heading into a meltdown of crashing incomes, crashing services and a crashing outlook. There is little the Central Bank can do to resolve that.
That’s the job of Government? What government? A government that is consumed by internal friction, has lost the trust of markets, while making noises about levelling up, but refuses to address the chronic imbalance and inequality between worker wages and inflation? It would cost to solve the current strikes – or you can let them fester. And then spice up the mix with a dose of austerity spending (caused by the loss of the UK’s virtuous Sovereign Trinity (Stable Currency, Sustainable Bond Market and Political Competency) last year), which can only make the outlook worse..
The market is not an intelligent beast. It is simply the sum of the votes of ill-informed and unware punters..
For months now I’ve been bemused and concerned about how markets seem determined to get the current macro picture absolutely wrong. They are running on the hope interest rates will fall and we’ll go back to overly market friendly low rates of the last 15 years. But that can’t happen, and Central Banks know it.
I am convinced we’re into a new normal economic cycle where Central Banks will keep interest rates higher to address embedded inflation, but also to correct corporate misbehaviours – forcing them to invest in real returns building plant and new product – which may or may not create real jobs. In the meantime, there is little can be done for the 1 in 4 consumers struggling to keep up because of inflation effects on housing, power and food – except hope that government offers solutions. Unlikely from the hamstrung UK conservatives..
For the new normal economy to works, Central Banks are betting on changes on behaviour: that wealth for sake of wealth will be replaced by real investment and productivity gains, while income inequality is flattened to promote broad based consumption – but I simply don’t see the political imperatives underway to support that. We need Central banks and Government cooperating to create a new normal stable growth economy. Can it happen?
So there it is.. a new normal economy. Higher rates. Less Market Friendly. Better for growth and consumption. And another good reason to invest in the real economy via alternatives than purely financial assets and speculative hype.
No time for Five Things
Out of time, and off to the day job…
Strategist and Head of Alternatives – Shard Capital