Within the Gavekal 4 Quadrants’ framework there is no discussion today that the world economy has moved up the chart from the disinflationary lower quadrants to the inflationary upper ones.
The next question thus becomes: right or left? In other words, boom or bust? The answer to this question has historically paved the way for reasonable hopes or disasters.
On June 13th, Emmanuel Macron announced that France and the European Union were entering a “war economy,” speaking as the newly re-elected President of France but also, possibly, as President of the European Union. No doubt he chose his words carefully.
But what does a war economy mean? What are its economic and financial consequences?
Let history enlighten us.
On February 24th, 2022, Russia attacked Ukraine. On March 3rd, the United Nations General Assembly adopted a resolution condemning the invasion and asking Russia to withdraw its troops. The vote in favor of the resolution exceeded 73%, an overwhelming majority.
A month later on April 7th, the Assembly voted to suspend Russia from the Human Rights Council. The majority dropped by 20 points to 53%.
Geopolitics had turned into geoeconomics.
Occasionally, Gavekal-IS publishes a seminal paper when deep financial instabilities light up from our quantitative research. For instance, February 2021’s “US PE Expansion: Game Over!” based on the statistical evidence that US inflation was about to kill equity multiples, as well as July 2021’s “Risk Off” on the statistical evidence that equity value for risk was shrinking. Today’s “World Crash Ahead” is the third of this trilogy.
Five conditions are met for a global market collapse.
The world of cryptocurrencies is a bit of a magical world, except of course for those already participating in the ecosystem. The king of this world, bitcoin, is the most volatile currency in history. Perhaps it is not a currency after all, but an asset, or even an illusion. But the conclusion remains the same, considering its size of about $600 billion: a value that fluctuates with 100% volatility.
The bitcoin has just collapsed, like the value of growth stocks or European and American government bonds. The market sends us a message – not a “Message in a Bottle,” as The Police band famously sang in 1979 – but rather, a “Message in a Bitcoin.”
Luxury is like beauty: Rare, immediately perceivable, extremely valuable, and quite difficult to describe.
From an economic standpoint, however, luxury has a very precise meaning.
If you wish to know whether the product you bought or sold is considered luxury, grab a pen, prepare yourself for some basic mathematics, and jot this down.
What might surprise you along the way is how health may be turning into luxury.
Inflation, growth, profits, energy supply. So many uncertainties today.
One definite macroeconomic fact is the US monetary policy. The Fed will take a new trajectory on its balance sheet in a few weeks, for months and potentially years: A sustained contraction of a trillion USD per year.
This is a first in world monetary history.
US CPI at 7.5% YoY and 5% in Europe, oil at more than $100 a barrel, Ukrainian refugees by the millions, wheat prices up 30% this year revealing possible food shortages to come in the Maghreb, European governments over-indebted by the management of the Covid crisis which, therefore, can only mean minimalist support measures in the face of the energy shock – a shock that will lead to stagnation in the next six months (likely recession), and FED raising rates by 0.25% this month – the first in an expected series of ten successive hikes – which cannot contain inflation as real interest rates will remain deeply negative… Despite the warlike rhetoric of Mr. Powell, central banks have lost the upper hand.
We are back to the real world.
The Rentier is busy doing many things but portfolio management. As presented in previous publications, they can allocate once and for all 25% of their savings in four repulsive asset classes: equities, long-term government bonds, gold, and cash. The outcome is a four-body stable system with remarkable statistical properties, successfully riding inflation, disinflation, booms, and busts for 70 years.
The Rentier’s portfolio passed its live stress test last week. However, today, the Rentier still does not sleep well at night given what he sees on TV.
They are searching for a cunning plan.
At 15% drawdown in equity markets compared to a market high, the probability of an extension of the drawdown by an additional 20% in the coming year is multiplied by a factor of 4 to reach 20%.
At 30% drawdown, by a factor of 10 to reach 50% (reference “The Snake That Bites Its Own Tail,” published in September 2021).
Risk begets risk.
Here are some crash risk indicators to follow daily in the highly troubled period we are currently experiencing.
Two macro factors – one economic and the other monetary – have each historically weighed on stocks multiples. These are inflation and the contraction of liquidity. The combination of the two factors today puts equity markets in serious danger.
What should central bankers do, stop contracting at the risk of runaway inflation? Continue contracting at the risk of a market crash?
So hard to start a new year! The counters are reset to zero. Nothing to preserve. Everything to gain – or lose. And how does one manage the investment risk when there is no accumulation of profits yet?
Here is the simplest of principles.