A Historic Dollar Rally, an Inverted Yield Curve, and an Asset Allocation Crossroads for the Ages
Part II of Volume I, Issue VIII
The chances of a longer-term bear market in stocks rose as the August consumer price index came in higher than expected and showed inflation continuing to outpace US economic growth. Historically, US equity bull markets are marked by periods where the real economy grows faster than inflation, the opposite of what’s happening right now. Consensus estimates suggest US consumer prices are likely to run hotter than the gross domestic product through at least the first half of 2023, according to Bloomberg Intelligence.
“Major bear markets of the past half-century were accompanied by inflation outpacing growth, such as the rapid jump in prices in the 1970s and a period of scant expansion and steady disinflation in the early 2000s,” Bloomberg Intelligence equity strategists Gina Martin Adams and Michael Casper wrote in a research note. Although inflation gathered momentum in the latter half of the 1960s, it didn’t exceed growth until the end of the decade, in-line with a peak in stocks in 1968...
- Bloomberg, September 13, 2022
Central banks are intent on driving the world economy perilously close to a recession. Late to see the worst inflation in four decades coming, and then slow to crack down on it, the Federal Reserve and its peers around the globe now make no secret about their determination to win the fight against soaring prices — even at the cost of seeing their economies expand more slowly or even shrink.
About 90 central banks have raised interest rates this year, and half of them have hiked by at least 75 basis points in one shot. The result is the broadest tightening of monetary policy for 15 years — a decisive departure from the cheap-money era ushered in by the 2008 financial crisis, which many economists and investors had come to view as the new normal. The current quarter will see the biggest rate hikes by major central banks since 1980, according to JPMorgan Chase & Co., and it won’t stop there.
- Bloomberg, September 18, 2022
Editor’s Note: This is Part II of Volume I, Issue VIII of The Macro Value Monitor. Part I, After a Decade of Decadence, the Early Dawn of Comprehension Hits the Federal Reserve, can be found here. A full PDF of this issue is also available.
Earlier this year, we looked at the monetary expansion in France that unfolded in 1719 and 1720, courtesy of the Banque Royale. Although the events surrounding the Mississippi Bubble are a worthwhile study at any time, since they illustrate so clearly the folly of monetary excess and the irrational exuberance it spawns, the specific timing of our discussion – January of this year – of the infamous John Law and the Company of the West was deliberate, and intentional.
If you recall, one of the pivotal moments in the Mississippi Bubble came when it suddenly dawned on Law, in the spring of 1720, that if the public lost confidence in the banknotes of the Banque Royale, his vision for the Mississippi Territory and the Company of the West, and his grand plan to pay off of the debt left over from the reign of Louis XIV, would fall apart. The supply of banknotes had grown 20-fold, and while the public had absorbed the flood of notes with enthusiasm because it enabled purchases of shares of the Company of the West on rue Quincampoix, there were alarming signs of growing instability and wavering confidence amid the exuberance.
The most alarming of these signs was a run on the Banque Royale in late 1719. Law managed to defuse the sudden rush to convert banknotes into gold and silver by issuing a decree banning the use of coin in public payments, such as taxes. Yet even with the decree, not only did the price of gold continue its ascent in the months that followed, but the price of property in Paris rose so high that many found they could no longer afford a home. The prices of everyday goods, such as meat and grain, were rising quickly as well – and merchant markets were becoming disorderly. By May 1720, Law realized that the only way to maintain confidence in the banknotes as a medium of exchange was to shrink the supply, which would bring the value of circulating banknotes back into better alignment with the value of gold and silver extant in France.
As happened to John Law in early 1720, Jerome Powell and the Federal Reserve had their own dawn of comprehension this year. For Powell, the earliest moment of realization came in November of last year, when he began to see that prices were rising for reasons other than those related to the pandemic. However, a deeper understanding of the need to tighten monetary policy set in over this past summer. And as that realization has set in, financial asset prices have more or less followed what happened following the first recorded experiment with “quantitative tightening” in 1720: stocks, bonds, real estate, and nearly every other financial asset has declined in price, as higher interest rates and the prospect of fewer dollars have reduced their present nominal value.
With one notable exception.
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