HeRe'S oUr 2022 OuTlOoK

Let's start with a picture of fireworks.

And a Tweet from myself...

 Strongly of the opinion that fireworks should only be allowed on NYE and 5th November.— David Belle (@davidbelle_) January 1, 2022 

Yes, I absolutely hate them.

What I also hate is the term 'Macro Fireworks/Macro Musing/Macro Thesis/Macro Outlook.'

Quite frankly, these terms are bollocks, since most of the pieces that are written on this come from a perspective that a New Year is going to ridiculously change things.

And they tend to be year on year based...

Which is fine, but also, I think when dealing with anomalies (which 2020 & 2021 was on a historical basis), we should look back to the longer term baseline, which in this case is obviously 2019 and before...

The way I'm going to structure this is to express MY view based on what I think is probable.

I'm not going to mention a tonne of different risks, since I don't think that's a useful exercise.

If you want that, you can read what the banks and asset managers reckon from this Bloomberg piece of short excerpts.

I'm keeping this concise and to the point.

No introduction of a million different themes.

Just a few central tenets to an overall trade thesis, with reference to articles from last year to form our view (most of our articles are centred around longer term themes where pre-2020 is still of vital importance).

Priorities

The fact of the matter is, inflation has dominated the headlines for the last 12 months or so.

I am almost ready to jump in front of a bus now when I hear a take on inflation.

Although it's an important metric, the constant chatter around it gives me a feeling of sickness, morbidity and a desire to swim to the bottom of the Marinara Trench and never come back up.

Yes, it's that bad and boring now.

But i think this breeds some opportunity.

Whilst everyone is talking about inflation and how it's going to sustain, or how we're going to enter deflation...

I feel that people have forgotten the baseline growth rate of the world.

World Bank

Yes, it's a shittily drawn line of best fit, but I think you get the picture.

Average global growth has been trending downwards for a long time.

Now why does this matter?

Well, we have to start considering that the last two years DON'T matter.

Which is good in part, but also leads to some confusion over how to analyse what's next.

The biggest confusoooor of all will still be the base effect conundrum.

What will data look like in two quarters time and then what will growth data look like in the two quarters following that?

And perhaps a better way to look at real GDP growth is on the per capita measure...

Source

See, post 2000, we saw a marked shift downwards in real GDP growth, well away from the long term average.

I am not going to get into why I think this might have happened because I don't think that's relevant for our analysis and can probably be debated in a future piece, but clearly what we are looking at is a lower average going forward.

The firm

Now something that is important to note about the next few quarters is how 'sticky' corporate earnings might be, and this is a factor of that word-that-begins-with-I-that-I-don't-want-to-name.

See, we're of the view that it will be hard for firms to maintain higher prices for a sustained period of time, especially with the issues surrounding energy prices (which, by the way, beat the SP500 on a YTD basis!).

You can read the full FactSet report below.

Essentially, we are seeing base effects still at play.

Last year's earnings were high due to the low base they were coming from.

Now, they're reverting back to normality...

What will be extremely intriguing is if there are misses here, since it would give us an insight into how much demand is still out there, especially at these higher prices.

In our minds, this creates a feedback loop which has a high probability of affecting that word-that-begins-with-I-that-I-don't-want-to-name.

This forms part of our reasoning for our view around that word-that-begins-with-I-that-I-don't-want-to-name (I'll stop after this) being transitory.

Let's take the example of Ikea.

Ikea is well known for its affordability and good value...

But something tells me that the price increase might stunt demand for their goods.

See, if I were someone who traditionally shopped at Ikea, I might now be saying, 'well I might as well spend a tiny bit extra on something that is slightly more robust and/or higher quality.'

Or not buy at all...

because the fact of the matter is, durable goods have been bid in SIZE during the pandemic.

Here's a Cleveland Fed report on this and why consumers chose to spend so heavily on said goods (durable goods are any goods that you don't buy regularly, so in this example, furniture)...

An increase in consumers’ disposable income during the pandemic may have stimulated consumption expenditures, including on durable goods.

Disposable income did rise sharply during the pandemic, whereas it edged up only gradually after the peak of previous business cycles (figure 1, panel B).1 

The idea that higher disposable income spurs consumer spending goes a long way back, to Keynes (1936), and is embodied in textbook consumption functions.2 

As the catalyst of the rise in disposable income, the pandemic may have indirectly provoked the durable goods spending boom.

What is really interesting about the piece above is this excerpt...

Specifically, the accommodative stance of monetary policy may have lowered borrowing rates for financing durable goods purchases and boosted asset valuations that contribute to a wealth effect on spending.

However, empirical research indicates that interest rate and wealth effects are relatively small, suggesting they may form a less important factor behind the fixed effect for 2020.

We have mentioned before that we are of the opinion that consumers are far less sensitive to rate changes than previous times in history, owing to the fact that rates are so low and the changes to the base rate can be measured in very small basis point changes rather than historically when they have moved >1% in many cases.

A couple of times recently we have spoken about this in the Morning Calls.

The faux-business cycle

What we have to remember about the last two years is that it's rather fugazi when it comes to discussing economic data.

At the end of 2019, we were coming to the end of the biz cycle in my humble opinion.

But 2020 & 2021's fiscal transfers were anomalous and caused anomalous outcomes.

We didn't have a proper recession when everything was shut down for fuck's sake.

No one lost their homes, unlike 2008, there was no banking crisis, stock markets remained buoyant and although unemployment was up, it didn't remain as sticky as it did in the post GFC years.

So have we delayed the inevitable?

I'm not calling for a recession, but I am calling for a marked slowdown in activity generally from the 20-21 data that we have seen.

I mean, take the comparison between excess savings in the earlier parts of the pandemic versus now...

And the data as of June 2021...

Why is this relevant?

Well, we have to consider once again what the marginal propensity to consume is and who is affecting the consumption stats in the US.

Here's some an excerpt from this Boston Fed paper, examining which household income quartiles have the greatest, and therefore least, MPC...

We also find that the MPC is lower for higher-wealth quintiles, which suggests that low-wealth households cannot smooth consumption as much as wealth-holding households at the same income level do, and therefore they respond more to changes in income per se. At the other end, wealthy households can more closely, even if imperfectly, follow the life-cycle/permanent-income hypothesis.

Essentially, household income is more volatile for households with lower incomes, and they are more likely to spend their excess savings - so with that, factor in what might happen to durable goods, as mentioned with the Ikea example.

Does this mean there is a subsiding demand effect coming in to play?

Perhaps.

I mean, we can look at yesterday's ISM Manufacturing index for some indication of this...

In blue, is the ISM manufacturing index and in orange is the 5y breakeven inflation rate, the market based expectations of inflation over the next 5y.

Note the correlation between the two data points.

Could we be considering that inflation has peaked off this measure?

Again, perhaps.

But what is even more intriguing is the prices paid number...

We had a BIG miss here...

And now check this out versus the inflation rate...

It tends to lead inflation by about three months.

Remember what I mentioned about looking a quarter to two quarter ahead?

This is what I mean.

And prices paid are a very important measure for inflation since...

It's about prices paid, so is naturally a good measure of inflation!

Demand Story

This is what it is about from here on in.

And this is what I've set up this article to focus on.

And this is proven, none other, by the prices paid versus gauge of supplier deliveries too!

How best would I like to express this idea then?

Well let's consider a piece from last year.

I am still strongly of the opinion that Canada is in the shit.

Read the article above to note some of the broader reasons why with regards to debt & emphasis on property.

As well as this, economic dynamism is key - as mentioned there, Canada is heavily focused on oil, leading to it being a pretty high beta currency.

Check out Tim's article on this.

It's pretty damn important (and very good).

So this is where I'd like to base the beginnings of my trade idea expression.

Remember, I don't like to complicate trade structures - I don't see the point.

In this case, you could just sell oil (and I am partial to selling oil as well - see here), as mentioned, but I think I prefer to add further context to the trade.

So let's take a look at yen.

It's had a really shit year.

It's been hammered by outflows of the sheer risk on nature.

Japanese investors looking for yield via carry into US equities.

It's a simple thesis, but is central to the theme.

A brief but interesting discussion I had yesterday was on the idea of 'mean reversion' and how it works better in FX than in a market like equities indices.

 They should extrapolate this to FX where it works better— David Belle (@davidbelle_) January 4, 2022 

This is a stats based reasoning.

If we take a crude measure of the past year, then we might be inclined to think that yen could initially push up 6% versus the dollar.

But versus CAD, I think it could do more.

Look at where CADJPY currently lies as well.

Right at a very long term trendline...

And there is a seasonality aspect too.

CADJPY tends to have some basis for a turning point in October.

Yes, this is curve fitting, and not a central tenet to the argument for selling the pair, but still worth noting.

There is a case to be made too that the Yen will rally when/if the Fed starts raising rates...

In orange is the US base rate vs yen futures.

What is also pretty cool about this relationship is that it goes in line with what Danske Bank says with regards to the dollar falling off ninety days post a rate hike in the US.

And the fact that the Bank of Canada are exceedingly dovish, builds the case for a weakening CAD going forward too, especially if we consider that demand/inflation may have topped out, and oil is a big factor in the demand equation.

Weaker oil = weaker CAD.

Currently, I am short CADJPY from 90.80 and 91.09.

And I do have some convicti0on behind this.

Naturally do your own research and take this as a piece to show you how to translate data to action!

Something else...

People are going a bit mad about yields at the moment.

Yes they're higher, but I think this might have something to do with it.