When looking through history’s pages
It seems there are only two stages
At times capital
Has markets in thrall
At others, it’s all about wages
Four decades past Maggie and Ron
Convinced us, for things to move on
T’was capital needed
For growth unimpeded
But seemingly those days are gone
Instead, now the cycle has turned
As two generations have learned
That labor should take
The bulk of the cake
While capitalism is spurned
The upshot is that now inflation
Will percolate throughout the nation
While central banks claim
That prices are tame
Your costs will increase sans cessation
With markets fairly quiet this morning I thought it would be an interesting idea to step back to a more macro view of the current financial and economic framework as I strongly believe it is important to understand the very big picture in order to understand short term market activities.
A number of prominent historians and economists contend that both history and the economy are cyclical in nature although long-term trends underlie the process. One might envision a sine wave overlaying an upward sloping line as a description. Now the period and amplitude of the sine wave are open to question, but I would offer that a full cycle occurs in the timeframe of 80-100 years. As per Neil Howe’s excellent book, The Fourth Turning, this encompasses four generations over which time each generation’s response to their upbringing and the events that occurred during those formative years result in fairly similar outcomes every fourth generation.
Ultimately, I believe it is valid to consider the cyclical nature in terms of the importance of the two key inputs to economic activity; capital and labor. It is the combination of these two inputs that creates all the economic wealth that exists. However, depending on the government regulatory situation and the societal zeitgeist, one will always dominate the other.
If we look back 100 years to the Roaring Twenties, it was clear capital had the upper hand as the administrations of Warren Harding and Calvin Coolidge maintained a very laissez faire attitude to the economy and watched as large companies grew to dominate the economy. Of course, the Great Depression ended that theme and resulted in FDR’s New Deal and ultimately the ensuing 40 years of government intervention in the economy alongside labor’s growing power. Forty years on from the Depression saw the height of government interventionism with the ‘guns and butter’ strategy of LBJ, the Vietnam War, the Great Society and also, the seeds of the next change, the Summer of Love. At that point, the economic effects of the government’s heavy hand were starting to have a negative impact, restricting growth and driving inflation higher.
Like day follows night, this led to a change in the zeitgeist and a change in the relationship between capital and labor. The Reagan/Thatcher revolution arose at a time when people saw only the negatives of government and led to a reduction of government control and activity (on a relative basis), as well as the beginnings of the financialization of the economy. Arguably, that peaked in the dot com bubble in 2001, or perhaps in the GFC in 2008, but certainly, ever since the latter, we have seen a significant adjustment in the relationship of the government and the governed.
My contention is that we are entering into a new period of labor’s ascendancy versus capital and increased government involvement in every facet of life. While this has manifest itself in numerous ways, from the perspective of markets, what this means is that the heavy hand of central banks is going to weigh even more greatly on events than it has until now. The myth of the independent central bank is no longer even discussed. Rather, central banks and finance ministries are now working hand in hand as partners in trying to manage their respective economies. And ultimately, what that means is that QE has become a permanent part of the financial landscape as debt monetization is required in order to fund every new government initiative. If this thesis is correct, the idea that the Fed may begin to taper its QE purchases starting next year seems highly unlikely. Instead, as I have written before, it seems more likely they will increase those purchases as the latest ‘sugar high’ of fiscal stimulus wanes and the economy once again slows down.
Interestingly, the most salient comments made today appear to back up this thesis. Madame Lagarde was interviewed on Bloomberg TV this morning and explained that a new policy shift would be forthcoming in the near future from the ECB. Recognizing that the PEPP was due to expire come March and recognizing that the Eurozone economy was not growing anywhere near its desired rate, the ECB is already preparing for the PEPP’s successor. In other words, QE will not end at its originally appointed time. In addition, she explained that they would be adjusting their forward guidance as the previous model clearly did not achieve their goals. (Might I suggest, QE Forever? It’s catchy and sums things up perfectly!)
So, to recap; the broad cycles of history are turning through an inflection point and we are very likely to see capital’s importance diminish relative to labor going forward. This means that profit margins will shrink amid higher wages and greater regulatory burdens. Equity returns will suffer accordingly, especially on a real basis as price pressures will continue to rise. However, debt monetization will prevent yields from rising, so negative real yields are also likely here to stay for a while. As to currencies, their value will depend on the relative speed with which different countries adapt to the new realities, so it is not yet clear how things will turn out. It is also largely why currencies have range-traded for so long, the outcome is not yet clear.
With that to consider as a background, I would offer that market activity remains fairly unexciting. For now, the ongoing themes remain in place, so, central bank liquidity continues to be broadly supportive of asset markets and arguably will continue to be so for the time being.
Turning to today’s session shows that Asian equity markets followed Friday’s US lead by rallying nicely (Nikkei +2.2%, Hang Seng and Shanghai +0.6%) as markets continue to respond to the PBOC’s modest policy ease announced last week regarding the RRR reduction. Europe, though, is a bit less bubbly this morning (DAX -0.1%, CAC -0.3%, FTSE 100 -0.6%). Finally, US futures are mixed with the NASDAQ continuing its run higher (+0.2%) but the other two markets less happy with modest declines.
Bond markets, after selling off Friday in what was clearly a short-term profit taking act, have rallied back a bit this morning with yields declining in Treasuries (-1.5bps), Bunds (-1.5bps), OATs (-2.0bps) and Gilts (-2.0bps).
Commodity prices are under pressure, with oil (-1.4%) leading the way lower, but weakness across both precious (Au -0.45%) and base (Cu –1.4%) metals and most ags. In other words, the morning is shaping up as a risk-off session.
This is true in the FX market as well with the dollar broadly firmer in both the G10 and EMG blocs. Commodity currencies are the biggest laggards (NOK -0.6%, CAD -0.45%, AUD -0.4%) but the dollar is higher universally in the G10. As to the EMG bloc, ZAR (-1.8%) is by far the worst performer as a combination of increased Covid spread and local violence after the imprisonment of former president Jacob Zuma has seen capital flee the nation. However, here too, the bulk of the bloc is softer with the commodity currencies (MXN -0.5%, RUB -0.45%) next worse off.
While there is no data today, this week does bring some important news, including the latest CPI reading tomorrow:
|Tuesday||NFIB Small Biz Optimism||99.5|
|CPI||0.5% (4.9% Y/Y)|
|-ex food & energy||0.4% (4.0% Y/Y)|
|Wednesday||PPI||0.5% (6.7% Y/Y)|
|-ex food & energy||0.5% (5.0% Y/Y)|
|Fed’s Beige Book|
On the Fed front, the highlight will be Chairman Powell testifying before the House on Tuesday and the Senate on Wednesday, with only a few other speakers slated for the week.
At this point, the market question is; will the dollar rally that has been quite impressive for the past weeks, albeit halted on Friday, continue, or have we seen the top? Given the breakdown in the treasury yield – dollar relationship, my gut tells me the dollar has a bit further to go.
Good luck and stay safe