Navigating a Confused Market

I’ve never seen such a confused share market in my 25 years of managing money. It’s mainly because investors overthink the situation when there is so much conflicting data and uncertainty. In my view the most likely scenario is the most obvious, Central banks will need to continue raising interest rates until inflation is definitively brought under control. Doing so will mean that they break something in the economy, and they create a recession. That’s the macroeconomic end game from here.

If so, then the only question is whether the wheels have already been set in motion or whether the global economy continues to be surprisingly robust, and it takes another 6 months for the downturn to occur. But eventually, Central Banks will kill inflation with interest rate rises and create a recession along with it. The longer it takes to get to that place, the worse the recession will be. This will lead share markets to fall significantly and central banks to then drop rates to help the economic recovery. Anything else is just head fakes, noise, and confusion.

Make no mistake there will continue to be a lot of noise and confusion because as simply as I have outlined how I think things will work out, the journey to that point is anything but simple. That’s what makes navigating financial markets so difficult. Part of the problem now is just how long it is taking to happen. Investors are generally impatient and overly optimistic, so the absence of bad news is mistakenly seen as good news. The reality is the bad news has just been delayed.

In the meantime, you can build a case using any number of facts and figures to make a plausible argument for almost any scenario. Every day I read and watch the best experts in their respective areas of finance from across the world do exactly this. Some are bullish, some are bearish, all have relatively rationale arguments. So, who is right??

The answer is to zoom out and take a logical approach. Everyone has their personal biases, whether it’s to the firm they work for, the field they are in, or the way they are currently invested. The best answer is to start from the start, use your own logic and keep it as simple as possible. So, let’s skip all the financial jargon and obscure facts and figures to support a narrative and go from the beginning.

If you print money, stimulate the economy, and keep rates near 0% for a decade you will eventually create inflation. The more you do this, the more inflation there will be. Funnily enough, as this was occurring there were many plausible arguments being made for the opposite. However, history will show that it did cause inflation.?

If you have inflation and do not raise interest rates inflation will get worse. Unfortunately, central banks took a long time to admit that inflation was a problem, and any number of plausible arguments were made as to why inflation was temporary. However, history will show that inflation was not temporary.

During both of the above phases, financial markets took all sorts of twists and turns along the way. Events that unfold over months and years are simply harder to see. But the simple logical outcome was ultimately true.

Now inflation has taken hold across the world. It moved from goods to services which makes it more entrenched. While the headline rate in the US is down significantly, core inflation has remained stubbornly persistent in the 5.3%-6.5% range for more than 18 months. Inflation across the world is continuing to surprise to the upside. All this means that Central Banks across the world have no option but to continue to raise rates or keep them higher for longer.

If you raise interest rates from 0% to 5% or more, you will break something in the economy. Still, it had to be done. Just because a downturn hasn’t happened doesn’t mean the economy is resilient. It more likely means it is taking more time to flow through the system. This is likely unavoidable simply because this problem has been created over the last 10-15 years of excess. The time to fix this situation was in not creating it.

If the economy is actually more resilient and unemployment remains at record lows in this environment that’s not the good news people think it is. It means there will be even more upward pressure on inflation and increases the likelihood of a wage-price spiral. That in turn means central banks will need to go higher for longer with interest rates to kill off high inflation. It still leads to a recession.

But it’s important to keep in mind this is the normal economic cycle. There’s good and there’s bad, booms and busts. From all of this, once the downturn hits it’s important to remember that it will also pass and the dawn of a recovery and new good times ahead. But in the meantime, don’t let the folly of the market fool you into thinking things are better than they are. If you are patient and prepared, you will avoid the worst and be able to take advantage of the buying opportunities that will eventually prevail.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.