Looks like bad news is good news again.
Bond market and equity markets were all over the shop last week.
The basic idea seems to be that share markets are priced on the goldilocks scenario – inflation coming down and unemployment not going up.
But the data is not playing ball.
Last week things were up and down like a yo-yo, but the release of the US employment report was a case in point.
America added twice as many jobs as economists were expecting. It was a massively strong result.
In response, bond yields surged to its highest level since 2007.
Which means that markets were worried that the economy might be too strong, that inflation would prove persistent, and interest rates would have to remain higher for longer.
Markets didn’t like that idea at all.
But then while yields surged on the headline employment number, we then saw that wages had grown much less than expected.
Hooray said markets, and yields came off a touch.
Good news is bad news. Bad news is good news.
We’re in that kind of market again.
But the key thing here is that we don’t know what stage of the cycle we’re at.
Is the post-Covid correction behind us? Or is it still to come?
As s Albert Edwards at Societe Generale points out, when you look at equity market valuations – particularly for tech stocks – the market is priced for the beginning of an upswing. Its priced for growth – growing revenue and growing profits.
But what happens if we’re not at the start of the cycle? What if the soft-landing doesn’t materialise?
What happens if we enter a recession with markets priced for a boom.
Markets will correct. In an epic way.
As he says:
“The equity market’s current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors’ bullishness was eventually squashed,” Mr Edwards wrote in a note.
“Just like in 1987, any hint of recession now would surely be a devastating blow to equities.”
And this is really the puzzle. With interest rates rising as much as they have, its been surprising that there hasn’t been more of a downturn.
The economy, and markets, have held up much better than expected.
But perhaps they haven’t.
Perhaps they just had stockpiles of cash to push the problem down the road, and the correction is still coming.
And that could be the case. Central banks are trying to hoover up the cash that let slosh into the system through Covid. The Money supply is shrinking quickly, and that’s got to have an impact at some point:
“The last few decades have seen economists (especially at the Federal Reserve) increasingly disregard money supply. Monetarists have been marginalised – if not dismissed as cranks. That is a mistake in my opinion. I wouldn’t call myself a monetarist, but when money supply weakness (not least the record 1.5 per cent year-over-year decline in eurozone M3 in August) is confirmed in the data, I sit up and take note.”
Now Edwards is a notorious bear. He’s a glass-half-empty kind of guy.
But still, it shows you just how much uncertainty is in the market right now.
And why we’ve still got a bumpy ride ahead of us, whichever way it goes.
JG.