- Similar to what happened in 2006-2008, a compelling investment narrative based on fundamental truths and half truths seems to be meeting an ocean of liquidity (managed by a system that is biased towards herd like behavior) in a relatively shallow river. The supercycle in commodities narrative is again the same while the money wrong footed in losing assets classes seems to be a couple of trillions more while the physical as well as financial markets for commodities are extremely shallow. Whether this episode turns into a self fulfilling prophecy before the eventual demand destruction of a double whammy sort of higher rates and less disposable income remains to be seen. This will not an easy ride by any means but we think we are closer to the beginning rather than the end of a mean reversion between financial and real assets.
- We have been in the higher growth & much higher inflation camp since end 2020. Our favorite asset class has been commodities while we recommended staying away from fixed income. We still like commodities but are slowly warming up fixed income and are getting ready to turn neutral especially if the Fed goes really hawkish and breaks markets only to throw in the towel later on in the year.
- Coming into this year we stuck with the inflation part but have become more concerned about growth and equities, especially DM indices such as the Nasdaq. We continue to view DM equities as in a longer term topping process and expect to see lower prices into the summer months. Using the S&P500 index as our benchmark for global risk appetite, we expect to see sub 4000 levels in the next two quarters. While our tactical view remains positive since the January low, the risk reward for bullish risk asset positions has deteriorated and we now think entering March with a broadly neutral stance will make more sense as another test of the lows looks possible. We’d expect that test to be successful and result in another bounce into April but which is likely to make lower highs as part of a rolling over/topping out process.
- But first step back a little and try to see where we are in the market cycle. Periods of “reflation” stimulate money & credit expansion and economic expansion which is good for stocks and later on commodities. In the latter stages of reflation, inflation starts picking up with a lag while the second derivative of growth starts to lose momentum. Broadly speaking this is where we guess we are on a global level perhaps with the notable exception of China and possibly Brazil among G20 countries. At this stage, inflation becomes more important for asset selection and inflation-hedge type assets, such as gold, commodities, inflation-linked bonds and to a lesser extent real estate. Especially in a highly financialized economy and/or one in which asset prices are important for wealth effects. Thus, when the amount of debt is large, a simultaneous turn in fiscal and monetary policies in less accommodative (again second derivative), there is a much bigger likelihood of sticky inflation accompanied by economic weakness.
- While it is impossible to forecast economic indicators with any degree of sustainable accuracy, this is also not really necessary for investment strategy. Getting the broader contours, trends and second derivative changes especially in growth and inflation is much more important.
Turkey’s Energy Shortage Reaches Critical Point
- When we take a holistic view on all the data and leading indicators we stick to our view that the next step is stagflation light: slower growth (which we do not yet to turn into a recession) accompanied by inflation which may decline a bit in annual terms but remains sticky at relatively high levels. This is the conjecture we continue to expect globally including Turkey and the US. There are differences across countries and notable exceptions are China and possibly Brazil among G20. But our main message in terms of investment strategy is that the global macro environment is becoming less supportive than what has existed over the past couple of years.
Fed Interest Rate Hikes Will Hurt Turkish Economy (And Other Emerging Markets) Badly
- Some of the dilemmas facing central banks and investors are as follows: Central banks are behind the curve on inflation with real rates negative around the world while PPI and CPI continue climbing to historic highs. Now in many they started tightening policy, while fiscal policies turn from tailwinds into headwinds and into a period of economic softening. So, central banks are in a hard place, which is largely of their own making. There does not seem an easy way out. Leave rates at negative and let inflation spiral out of control? Raise rates too much and too fast and crush markets and possibly the economies?
- Last but not least, our base case continues to be that the Fed and other central banks will continue to tighten until it results in a sharp but relatively short (say around a year) bear market rather than a 2008 GFC type crisis or multi year bear market. Meanwhile, one important factor not discussed enough is the structural growth story in commodities used to transition into green energy. Apart from the potential financial flows into the asset class, this structural transition is probably decoupling from global GDP growth and thus could turn out to be much less sensitive to economic growth slow downs. This is among the reasons to expect inflation to remain sticky at higher levels for longer and our preference for inflation assets as well as EM over DM and value over growth. Our favorite sector remains mining.
By Murat Berk, chief strategist, Yapi Kredi Invest
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