A New Bull Market?
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First, an update:
Last year, we at Consilience Asset Management added a Macro-Economic component to our Relative Capital Flow Model*. Using market action, through a process of reverse engineering, we seek to identify which macro-economic climate is being represented in the market at any given time.
This is an important addition to our discipline as central banks across the globe are attempting to unwind decades of monetary expansion. As this unwinding occurs, it could have significant ramifications for the financial market. Thus, there is an increased need to monitor this process and the corresponding macro-economic result.
Below are the ratings of securities in the five scenarios that we are monitoring:
Inflation – Negative,
Deflation – Negative,
Stagflation – Negative,
Recovery – Neutral,
Financial Crisis – Negative.
The above scenarios reflect the current Capital Flow* composite rating of the securities that have historically generated positive returns in the above economic environments.
In addition, our Global Macro Indicators* are as follows for the seven asset classes we invest in for our clients:
Global Equities – Neutral,
Global Bonds – Neutral,
Commodities – Neutral,
Gold – Neutral,
U.S. Dollar – Neutral,
Real Estate – Neutral,
Cryptocurrencies – Neutral.
Now, to this month’s report:
It has been over 750 days since the S&P 500 last set an all-time high on January 3, 2022.
Today, many investors believe that both stocks and bonds have moved "too much, too fast" into the start of 2024, with widespread expectations of a "healthy pullback" soon..." or even a resumption of the 2022 “bear market.”
For others, it’s the end of the “bear market” and the beginning of a new “bull market” as the Fed begins a new round of money printing/Quantitative Easing (QE).
In so doing, they will once again provide liquidity to the banking system which would likely provide a favorable backdrop for the stock market.
Note, in Charts 1 & 2 the upward trajectory of both stocks and the Fed’s Balance Sheet (QE) from 2020-2021 as the Fed engaged in a major QE stimulative program during the Covid crisis. This was followed by a downward trajectory in stocks in 2022 as the Fed reversed course and contracted the money supply through a process called Quantitative Tightening (QT).
Chart 1
Chart 2
But then something interesting happened. The Fed continued to contract its balance sheet (QT) as shown in Chart 2, yet stocks resumed their upward trajectory Chart 3.
Chart 3
The best explanation for this divergence is that stocks are rising in anticipation of a new round of money printing (QE) this year. This would certainly not be unprecedented in an election year. However, would it be prudent?
Before answering, let’s review the reason why the Fed discontinued QE and introduced QT in late 2021. It was an effort to contain inflation. Their thinking was, if they contract the money supply, it will slow the economy and thus reduce inflation.
At first glance, it appears to be working as the Consumer Price Index (CPI) peaked in early 2022 and has been declining as a result of QT.
Chart 4
But, with the Fed printing again, will inflation re-emerge and undo all of their QT efforts, requiring a need for a new dose of quantitative tightening in the future?
On top of this risk, are there other factors at play that could prompt them to take such action?
Yes.
Number one is to recognize that monetary stimulus or quantitative easing is code for “money printing.” And money printing is accomplished by issuing more debt.
Here’s a graphic picture of where this has led us:
Note at the bottom right of the above picture, the US debt-to-GDP is now at 122%. A level above 100% is considered fiscally and economically dangerous.
As discussed in previous Consilience Market Notes, such elevated levels can require higher borrowing rates to finance the US’s ever-increasing debt. Yes… “ever increasing!”
Last month the U.S. Treasury reported the December budget deficit, which shows the U.S. collected $429 billion through various taxes while total outlays hit $559 billion, adding an additional $130 billion to the national debt.
A second factor that could result in higher inflation can be found in the Red Sea, where the behavior is truly worrying. So far, the markets are overlooking how much worse this can get, how inflationary it could prove to be, and how hard it may be to resolve.
The Strait of Bab al-Mandab is a strait between Yemen on the Arabian Peninsula and Djibouti and Eritrea in the Horn of Africa. It connects the Red Sea to the Gulf of Aden and by extension, the Indian Ocean.
This is a vital maritime choke point of immense strategic and economic importance.
Approximately 6 million barrels of oil and goods worth around ten billion dollars pass through this narrow waterway every day.
That’s about 12% of the world’s shipping traffic. Its geographical importance is underlined by its location at the junction of the continents of Asia and Africa, serving as a crucial passage for maritime routes connecting the five continents.
If the Bab al-Mandab were closed to Israeli and their allies’ ships, the consequences would be far-reaching, leading to longer delivery times for oil and goods, affecting supply chains and global markets.
The blockade of the Bab al-Mandab Strait and the resulting inflationary pressures and logistical challenges could greatly impact international markets.
In light of these facts, what should an investor do?
The good news is that there are asset classes that can perform favorably under multiple scenarios. Historically stocks do well when rates are declining, and money supply is expanding. Commodities and Gold have performed well when the increased money supply has resulted in inflation and Bonds have performed well during a contracting economy and declining interest rates…
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