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Not All Doom And Gloom: Macro Roundup
Zoom out, and the markets are looking surprisingly healthy - despite serious global concerns.
We're now almost 10 months into a very turbulent year, and the situation is unfortunately looking set to get worse. The war between Israel and Hamas is unlikely to have an imminent or neat conclusion, instead threatening to spill over into a regional conflict. This, of course, takes place against the backdrop of wider unrest, including the Russia-Ukraine war.
These wars have serious global implications, as we have already found, including pushing up inflation through disruption to supply chains and energy flows. Many traders have also warned of serious consequences for the markets, with dire warnings on social media about the possible ramifications and new "black swan" events on the horizon—especially when other factors such as the impact of higher-for-longer interest rates are considered.
From an emotional standpoint, that's understandable—but the picture may not be as bad as the doomsayers claim. As ever, none of what follows is financial advice. The main purpose of this article is to put what's going on today into a bigger context.
Be Cautious (About Caution)
Things look bad, there's no denying it. But we need to maintain perspective.
- Fear sells, optimism does not. On Twitter (many people's chief source of financial news/advice), doom is clickbait.
- "Black swan" events do happen, but they are by definition impossible to predict. Be wary, therefore, of people who predict them.
- Markets are forward-looking. They tend to look through the immediate situation (albeit with some knee-jerk volatility when news first drops) into the longer term. Right now, they're not expecting WW3.
- Markets tend to put in lows when things look bad, not when they are bad. All too often, retail traders sell the fear, while smart money buys it. The COVID crash of March 2020 is an excellent recent example of that.
- Uncertainty is a historical constant. Wars are perennial. But life, for the majority, goes on. Economies don't seize up—in fact, often the opposite.
This chart shows the S&P 500 putting in a strong rally between 1942 and 1945: The years within which the US was involved in WW2.
Let's zoom out from the daily ups-and-downs of the markets and take a look at the big picture.
First up is the all-important US dollar. It's relatively early still, but it looks like the dollar has just topped out after a very strong run from below 100 in mid-July to 107 in early October.
Moreover, that's a lower macro high from the October 2022 peak of almost 115. That could well be setting the dollar up for weakness going into the remainder of this year and 2024.
For a little more context, here's a chart of the dollar since the late 1960s.
There's a series of lower highs since the peak in 1985, and higher lows since 2008. Right now the dollar is a little higher than its long-term average, so even normal mean reversion would mean incoming weakness.
Breaking below 105 would likely confirm a move lower, which could play out on the scale of months at the very least, if not years. The case for that would also be strengthened if interest rates had indeed peaked (see further below).
If the dollar does fall, anything priced in dollars will rise, all else being equal.
Gold is worth a look as the traditional safe-haven asset in times of war and uncertainty. While it has been feeling some pressure from the strong dollar, it's holding up pretty well and is up strongly since the attack by Hamas on Israel. Zoom out, and the picture becomes clearer:
There have been three clear tops on the chart, playing out over the past three-plus years. Pushing through that resistance to make new all-time highs would not be unexpected, given gold's safe haven narrative and a weaker USD—assuming, of course, that plays out.
Again, this would likely occur on a timescale of months, at least, with gold's cycle not peaking for years.
We'll take a brief look at bitcoin here too, since it's highly sensitive to interest rates and dollar strength. It's harder to be objective about bitcoin, because as an asset class it has only been around a relatively short time. Its total trading history is less than 14 years, and it has only really been on the radar of institutions and corporate investors for the last few years. Necessarily, then, we can't take the same big-picture view that we can for the dollar and for gold.
All we can really do at this point is make a few observations:
- Following a year-long bear market, bitcoin put in a low of $15,500 in November 2022, almost a year ago.
- It has since made a series of higher lows.
- It has yet to break resistance at $30-32,000, but has made higher lows following each local top at this level.
- There is significant interest around Bitcoin spot ETFs, with multiple trillion-dollar financial institutions seeking to launch one.
Bitcoin is not currently doing anything it has not done in prior market cycles. It is currently around 60% down from its all-time high, which is in line with the 2015 and 2019 post-bear years.
We see no immediate signs in the structure of the market that BTC is in any imminent danger of breaking down to challenge its November 2022 low, or make new lows. Multiple layers of support would need to fail for this to take place. However, greater confidence will only come if and when BTC pushes above $32,000.
The backdrop to all of these markets is the critical role played by the US dollar, and by the Federal Reserve, which is in charge of setting interest rates. As we have drawn attention to before, higher (or higher-for-longer) interest rates strengthen the dollar because traders can earn a better risk-free return, and therefore sell riskier assets to buy USD, which can be parked in savings accounts, bonds, and money market funds.
The Fed has been hiking interest rates aggressively for the past year in an attempt to control inflation. The market currently believes that interest rates have peaked, with the expectation that rates will stay the same and start to fall later in 2024. However, this outcome is only just considered more likely than one or more further rate rises. The Fed's stance can change quickly as new employment and inflation data is published.
What we can say with a high degree of certainty that we are almost at, if not actually at, the peak of interest rates—which have risen from their low, just above zero, in February 2022, to their current range of 5.25-5.50%.
Government bonds have had to keep pace with interest rates, which has meant existing bonds crashing in price to push up yields.
Ten year Treasuries are close to 5%. The ten year is particularly closely watched, because it's a longer-duration bond that encompasses a full business cycle. These bonds have typically been considered very safe, but that safety comes at the cost of lower returns.
The current high yields are significant for a number of reasons. Investors obviously expect high inflation and high interest rates into the future. The 5% yield also means it's more expensive for the government to borrow money; a larger percentage of tax revenues will be spent on repayment. 10-year bonds also influence mortgage rates, making it more expensive for people to buy a house—or remortgage when their existing deal comes to an end.
The average interest rate on a typical 30-year mortgage in the US just hit 8% for the first time since 2000. If households are spending more of their income on mortgage repayments, this may have a serious impact on the wider economy and real estate markets. The risk is that the higher rates needed to dampen inflation will also crush economic growth, bringing about a recession.
While this is bad news for individuals and the economy as a whole, high inflation is a persistent and serious risk. In terms of the markets, traders tend to look ahead, so recessions do not coincide with market bottoms.
Overall, then, while there are many things to be concerned with in the economy and the world in general, these do not always reflect upon the markets in the way that people assume. We'll leave it there with a quote from legendary investor and philanthropist Peter Lynch:
Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.
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