What Market Optimism Is Missing | Financial Times

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Good morning. it Cathy Martin. Exciting times: Rob is on sabbatical this month. This is one of the best perks of working at the FT, even better than the famous weekly cake cart (only available in the London office).

While he’s away, I’m one of the people called in to help. I am tempted to use this opportunity to glorious lionesses or destroy some of Rob’s most prized beliefs on his own platform, created with love, such as extolling the virtues of the Birkenstocks. Have hate themand he is wrong. This is the hill where I will die.

See you again next week. In the meantime, say hello to Cathy.Martin@ft.comor complain about things to ethan.wu@ft.com.

Mixed market histories

Nobody knows what is happening on earth. Or, at least, market participants demonstrate an unusually high level of intelligence, holding two opposing ideas in their minds at the same time. Let’s say the last one.

This observation by Adam Cole, currency analyst at RBC, is surprising and sums it up pretty well. The chart tells you that yes, investors think the Fed will keep raising interest rates from now on (see blue line), but also that very soon after it does, it will start cutting them again (black) :

It’s strange, “completely unprecedented,” according to Cole. He adds:

The markets never discounted the Fed’s significant easing during the two years that the Fed was still in the middle of a recovery cycle.

So you are not imagining. Now we are really swimming through powerful counter currents. The dominant theme is the abrupt shift from doom/despair to cautious optimism, which makes sense given the apparent belief that the Fed will ramp up until it hurts.

So far, cautious optimism is winning. Global Developed Market Shares jumped up nearly 8% in July, due in part to some solid gains from tech megastocks that still have (dangerous?) excessive influence on the overall direction of the market.

For this to make sense, again, several conflicting things must be true at the same time. Drops (correct) should be ok actuallybecause of all the looser monetary policy they imply and/or the peak of fear has passed and/or the markets have already priced in sticky inflation and a hard landing.

Maybe, as with UBS Wealth Management, people were running the numbers and decided that waiting was for the weak. From Friday’s note by UBS Wealth chief investor Mark Hefele (my highlights):

Today, after a 26% downgrade over the past 12 months, the S&P 500 is trading at a price-to-earnings (P/E) ratio of 18.3x. a level that since 1960 corresponds to annual returns in a healthy range of 7–9% over the next decade. . . .

The idea that waiting can be riskier than investing immediately also supported by historical data. Since 1960, a strategy that waited for a 10 percent correction before buying the S&P 500 and then selling at a new all-time high would have been 80 times worse than a buy and hold strategy (yes, eighty times). Over the same period, an investment strategy immediately after a 20% drop would have provided an average annual return of 15.6%. Staying in the money for a year after a 20 percent drop means a significant opportunity cost.

Of course, but there is a real danger of overthinking it all. As Luca Paolini of Pictet Asset Management points out:

Be more simple. Stocks and bonds are recovering mainly because the first half of 2022 was the worst in terms of real returns. Worse than in 1932!

His chart here, showing how a theoretical 50/50 portfolio of U.S. stocks and government bonds could perform for almost a century, rather confirms this point:

Diagram by Luca Paolini showing how a theoretical 50/50 portfolio of U.S. stocks and government bonds could perform for almost a century.

Whatever the reason, this rally can eat its own tail very quickly. Brighter markets mean easier financial terms — the opposite of what the Fed wants to see, especially after a consistent 75 basis point rate hike. All this gives the Fed the opportunity to put on the brakes even more.

Readers with short-term investment horizons may still be tempted to find out how long this will last, and good luck to you. Investors with longer plans are usually less inclined to try to be a hero. A few days before the latest Fed report presumably pigeon around the corner, I asked Sonya Laud, Chief Investment Officer at LGIM, if the stock markets had capitulated, and if it was time to take the courage to intervene.

“There is no rush for me,” she said. “A number of large goalposts are shifting. We never appreciated the value of globalization [that we saw] after the fall of the Berlin Wall and the collapse of the Soviet Union. . . Just-in-time supply chains have been a huge benefit for consumers around the world and for business profitability around the world.”

Now globalization is not quite dead, but it is wearing out, changing the dynamics of profitability and inflation. “We are saying goodbye to the post-World War II order that we all took for granted,” she said. “This is history in the making.”

Seen through this lens, it seems premature to announce that this difficult period in the markets is over. The process of figuring out how supply chains and inflation deal with geopolitics will not be quick, and false dawns will catch investors off guard. All the clichés are true: stay humble, stay nimble.

Catch Cathy’s eye

Betting is rising that the Bank of England will raise rates by 50 basis points this week. as Bank of England governor Andrew Bailey previously hinted.. Doing 25bp is like that before the coronavirus pandemic.

Everyone hates Europe. “Investors are looking at Europe in a new and positive way” is the main article of financial journalism. I know this because I myself have written or edited these stories several times. However, right now Europe is really struggling to keep the fan club going. Goldman Sachs said on Friday that it believes the Euro Stoxx 600 could drop another 10% this year. “We think the market as a whole is overly complacent about weak growth and risks posed by Russian gas supplies and Italian policies that are skewed to the downside,” Sharon Bell and her colleagues at the bank wrote.

Unlike any other large stock index, the FTSE 100 is currently in positive year-end performance. The first person to tell me it’s a truss effect will get the hardest looks.

If you haven’t already, read it, on the Russian economy. It’s not beautiful. Top line, again with my highlight:

a common narrative has emerged that the unity of the world in confronting Russia has somehow turned into a “war of economic attrition that hurts the West,” given Russia’s perceived “resilience” and even “prosperity.” economy. It’s just not true.

If you can bear it, look at the myriad ways the crypto industrial complex is ridding people of their money and “Meet the ‘psychic’ crypto enthusiasts who sell bitcoin information to thousands“. (Sifted, with a heroic definition of the word “information”.)

One good read

We can’t get enough of Neom, the part fun, part crazy desert metropolis of Saudi Arabia. Its design hops between the “Death Star’s dystopian evil empire, the apartheid architecture of a post-apocalyptic security city, and the depiction of a glamorous and unlikely central business district looking for gullible investors.” writes architecture critic FT.

Cryptocurrency — Scott Chipolina filters out the noise of the global cryptocurrency industry. Subscribe gentlemen

Swamp Notes— An expert look at the intersection of money and power in US politics. Subscribe gentlemen