Financial Markets Update 2023/08/24
I am not a financial advisor, nor should you take anything contained in this article as financial advice. It is simply my opinion based on how I am looking at markets. Always consult your own licensed financial advisor before making any financial decisions.
CURRENCIES
The USD dipped the past couple months and is now on a tear higher. This is not a good sign for liquidity or international markets in general. In combination with what seems like overwhelming deflationary trends in China and high interest rates affecting economies around the world, it looks like this recent rush to dollars is a flight for safety and also a scramble to pay dollar denominated debts by selling collateral. We may be at an inflection point for a global recession and the dollar may be the canary in the coal mine. If China doesn’t do a massive stimulus package and make concerted trade initiatives, I expect the dollar will continue to go higher. It’s probably a good time to be holding dollars both for the appreciation and against the risk of falling investment values around the world (probably in the US too).
STOCKS
This whole year has been a story of the meteoric rise of the Nasdaq 7 and the concurrent slow sinking of pretty much everything else. Optically it looks like markets have fared ok, but if you look closely the breadth is very very narrow. This is always a bad sign in markets this late into a business cycle. We haven’t really had a recession since 2008 because the Fed has propped up assets every time we start to dip. The tightening over the last 18 months is the first time the accommodation has not flooded in (although they are still using some tricks to provide liquidity when banks fail). Can Nvidia et all continue to gain at 10% every month forever? Obviously it has to stop at some point, but when. The recent blowout earnings only prove that AI is a real trend, but markets have a thing called profit taking… Even if the predicted valuation 5 or 10 years down the road is correct, people get antsy and sell all at the same time to lock in their 50, 100, or even 200+% gains. I did, and I expect even the most greedy will start to look at their balance sheets and think about locking in the cash. The economy is showing signs of real constriction and that has a psychological effect on stock owners that builds up over time. I think given some of the economic milestones ticking over in the Fall, continued higher rates, and expected higher inflation prints, that it will be enough to convince greedy investors to sell, in so much as to lock in gains before year end. It’s been too good a run.
COMMODITIES
Commodities have had a broadly down year in 2023, although still remain at elevated levels compared to pre-pandemic. Commodity bulls such as myself take solace in the fact they haven’t broken down, and supply constraints continue. At the same time, markets have clearly moved towards tech and away from commodities so there are no tailwinds to investing until tech breaks down, in my opinion. Shrinking China GDP growth also bodes ill for commodities as well as the increasing export bans on advanced tech from the US, Japan and others. For security reasons and other unknown politics, the West is closing the door on China’s high-tech ambitions while also adding knock-on wealth and industrial order destruction. It begs the question, does China have enough commodities locked-up already? Will they scramble to secure more supply lines? Will they engage in diplomacy to restart trade demand, or hunker down and prepare for war posture? The case for commodities is unclear given these questions. Looked at in a more granular manner, I think metals and other commodities like lumber, grains etc. are the most vulnerable to a China slowdown. I don't want to be accumulating in those areas until things become more clear and they are at a further discount. Energy is a different situation. Demand looks to have hit a floor regardless of outcomes, and many of the negative economic outcomes such as war could actually provide upside shocks to energy prices given how inelastic demand already is, and how long it takes to bring supply on board. Canadian energy stocks look cheap still, as do some incredibly high dividend companies in latin America. Even some of the big US companies seem like a safe alternative to fixed income. I am keeping 25% of my portfolio in affordable, strong balance-sheet energy.
FIXED INCOME
Fixed income just gets better by the day. Short duration above 5%, long duration around 4.5%. We haven’t seen this in 40 years. Inflation is likely to remain high for years to come as the Fed and governments around the world continue to spend into deficits. Bond yields will probably go higher in the long term and we may enter a hyper inflation situation in many smaller countries. But short term, especially given present economic and geo-political risk, 1-5 year bills/bonds look great. Money market ETFs can be even more dynamic. If you are not confident in playing the tech or energy markets, bonds seem to be the 3rd leg of the stool. Short term I’m looking at 25% allocation to bonds. Some elderly people could go much higher.
OUTLIERS
Some of the things I’ve got on my watchlist are:
Russia seems to be consolidating its war machine finally after a lot of bumbling. Shooting down Prigozhin’s private jet over Moscow seems like a clear message from Putin that he isn’t going anywhere, and that Belarus is firmly a member of the Russian plan. I wouldn’t be surprised to see a major offensive from Belarus to finally silence Zelenskiy. I think Putin will be happy to win the war of words by eliminating opposition voices alone, without any land gains. It’s a cost effective way to stay in power that has a lot of historical precedence in Russian affairs.
China fails to reinvigorate trade or re-open high tech development. Xi has too many people to keep happy to allow the economy to go into recession and I fear that if the sanctions against China work, he will mobilize on war as a means of unifying the population under his control.
The US economy may finally fall off a cliff. Residential mortgages look fine because of the prevalence of 30 year mortgages, but commercial looks like a dead man walking and that means a lot of banks are under water. Everyone’s pretending things are fine, but with long bonds being devalued every day, it seems like about 25% of regional banks are essential bankrupt in a mark-to-market regime. Yes, the Fed can backstop all of them with guarantees but that doesn’t help the bond market or the long term debt situation either. I fear that some combination of multiple factors outside the US, plus a few bank failures could lead to a critical week of events that causes a massive implosion amongst bond sellers and stocks simultaneously.
CONCLUSION
2023 hasn’t gotten any more secure as we’ve gone on. The cyclical recession everyone expected at the beginning of the year has not materialized, and we’re really long since the last one. The world is playing on doomsday politics in a way not seen since the early 80s and the debt levels everywhere are ridiculous. What can investors do? Think short term. Find the bargains. Take away risk using high yield short duration fixed income devices. Keep cash. It’s an interesting time. I think by Q4 we will have seen at least a mild recession, as well as some resolution of geopolitical questions. Even if these turn out bad, the confirmation will yield some opportunities in either bonds or energy.
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