Raoul's masterclass is held in the backdrop of the Fed's ongoing and potentially continuing rate cuts, Russia's Ukraine invasion and subsequent oil shock, pandemics after the effects of supply/demand shocks and finally countries dealing with spiralling debts. Raoul is taking us through his process of analysing the current landscape with 50+ charts across various key indicators of industry against the past 30-40 years in some cases even 100 years.
Raoul's macroeconomic thesis:
In summary, Raoul believes that liquidity tightening from the Fed will bring inflation down, but as a consequence of the credit tightening the economic and employment growth will slow down. These factors will bring economic stimulus of some kind back into play using; either monetary, fiscal or debt tools. At that stage liquidity increases and growth is brought back. The equities will be picking up cues from the leading indicators from the macroeconomic playbook and then will take new highs. But that's how tactical one wants to be.
Bond markets have already taken into price the Fed's response. If Fed's balance sheet stays steady then bond yields come down drastically. That is an indicator of recession. When the Fed's balance sheet adds more assets, the bond yields will go up as more growth and inflation are coming our way
But there are secular trends one should follow or bet into regardless of the liquidity patterns. Yes, of course, those are opportunities to rotate your investments from one asset to another following the trades available. But you also have the option to just stay the course on a high-performing asset class and secular trend and make a similar effect with much-reduced effort and risk.
The world is undergoing a dramatic shift in industrial productivity impacted by exponential technologies like deep learning, language models, robotics, automation, electric batteries, renewable energy, bio-informatics, bio-engineering, digitisation, financial technologies, digital currencies, smart contracts, virtual reality, communication technologies, mobility, edge devices, networks and so on. In most cases, these technologies are improving by a factor of two every 2 years or even less. When this doubling is stacked one upon another, you are starting to bring in 10X effects in 2-3 years of time frame. That's exponential by any measure. In a way that the world is not ready to deal with from a societal change standpoint.
If we bring in the effect of demographic changes and retirement effects of the baby boomer generation the model to analyse the change becomes even more complex. Further, you have the effect of debt and the subsequent debasement to consider. The remaining two of the trio effects driving growth (Demographics, Debt and Productivity).
Diversification is a key principle of investing, however with the above phenomenon which we never experienced before at this scale diversification is a way to impede your wealth generation by investing in subpar asset classes. However, for the conservative investors - gold will rally due to the de-dollarisation effects - that's a reliable asset to go for, similarly, bonds will outperform for a period of time. However, none of those diversification makes a huge amount of sense for the retail investors as much as it would be for the fund managers with large capital allocations to make and returns need to be moderated.
Here are the key observations from the presentation:
Why of Inflation: Demand side shock, with so much falling behind on the commodities and finished products. But, commodity inflation is slowing down, food inflation is still ongoing, shipment container shortage, rail car loading, and container clearance from ports are improving and we should see supply side easing. Likely the inflation will taper quicker than everyone expected. The business cycle is the main predictor. Fiscal stimulus is likely to reverse the business cycle impactsInflation will cause demand destruction. But will that impact commodities or oil prices? Among commodities, looking at the charts demand destruction will impact oil prices.
How do we understand where inflation is going:
ISM Manufacturing PMI is the leading indicator of the recession and its compared with other leading indicators
Chinese credit impulse is a leading indicator by 12 months of the ISM supply index.
Retail fixed investments are coming out - forward-looking indicators
US Small business optimism is a leading indicator
Household sentiment is very negative - government money is gone and inflation is been high. The retired people will be the most hit as their incomes don't appreciate at the same pace
US personal income is also coming down.
The workforce is contracting and the ones out of work take the full brunt of this.
Real wages are still negative
30-year mortgage rates are the highest in a decade. Just when people have bought a new house during the pandemic.
Mortgage servicing costs are 94% from the lowest point
The US Financial Condition Index is tightening
US PPI - producer price index - 18 months lead indicator, its going downwards very fast indicating the ISM index will go fast downward too
Secular cycle: Debt, demographic, deflation, technological growth, globalisation + business cycle.
The rate of change of the business cycle is equal to the rate of change of the asset prices
The S&P500 rate is going down 40% down and ISM may go down below 47 which is a recession zone
The dollar is the big daddy global macro world. The dollar is going up business cycle goes down and vice versa, it's highly correlated
US 10 year Bond rate
Fed balance sheet versus bond yield curve
What are the precedences in history for the current economic conditions:
1974 oil embargo and its effect on inflation and how sharply the demand destruction happened. But they all came back quickly because baby boomers came into the workforce in the mid-70s, creating new sources of demand. We don't have the same or similar drivers in 2022.
The 2022 situation is more like what it was back in the 1940s. The post-World war world experienced a supply-side shock, and everything needed to be rebuilt. Coupled with that the population exploded in the maritime. All these nations out of the war were highly indebted. What happened was moderate inflation with moderate interest rates, resulting in debts eroding over time and prosperity returned. 2022 sounds similar - pandemic debt, supply-side shock, demand explosion, inflation, monetary tightening etc.
Further, we will see that the inflation is likely to increase with retooling required by the increased automation of the manufacturing and its relocation back from China and other low-cost locations, back to the US. Those new US factories don't need a lot of workers which means this relocation eventually will have a deflationary effect on the wage and growth.
Over time average inflation and average interest rates considered, the real rates were negative and this was a boon for the equity markets or for the new age industries - the funds are better deployed into high growth-moderate risk enterprises rather than sat in the bonds.
What are the specific investment ideas for viewers:
The options for governments to fight the business cycles are 3 folds - 1) monetary policy with central bank rates being the key lever 2) fiscal stimulus - ie direct transfer of subsidies and benefits and tax cuts right in the hands of the consumers 3) quantitative easing where the government balance sheet is used to generate new money - or central banks will buy more bonds from the government with artificially created money. Monetary policy as a lever was used extensively in the era of 'great moderation' and eventually suppressing the business cycle - only to see that the business cycles came back with fury (as such artificial smoothening of business cycles created debts in the scale which were not sustainable). In 2022, we will expect governments to do a combination of all three - but more weighted towards quantitative easing delivering fiscal stimulus.
2022 Inflation peaked, interest rates peaked which means growth will come down and subsequently inflation will come down. It does mean bonds will become dearer for some time. It is a possible trade to make. The only spoiler for that trade would be an event like China's invasion of Taiwan.
2022 Equities have tanked, based on expectations of a series of rate hikes from the Fed. Typically market responds with force and growth comes down drastically forcing the Fed to respond with rate cuts or or resisting further cuts. That means equities will roar back into new heights all over again. But what to buy - that has to be exponential growth stocks which are bringing in tectonic shifts in the markets - robotics, biotech, EVs, AI, metaverse, gaming, automation, devices, networks, data centres, financial tech and so on. When the Fed reacts with a recovery measure of either monetary or fiscal policy then the equities will rally next high
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