Thursday, January 5, 2023

History Will Rhyme Again

There are two immutable Laws Of Nature:

  1. Disorder always increases (Second Law Of Thermodynamics)
  2. History Rhymes
Take those two together and you quickly come up with waves, Elliott theories, Fibonacci ratios... even astrology.  Basically, in order to maintain systems/economies/markets/life on an upward trajectory we need to keep adding ever increasing amounts of energy/resources.  The higher we go the more the energy and resources that are required. At some point the system becomes unstable because the net returns are not enough to justify the energy/resource expense, and we get recessions/depressions/crashes.  The details may be different each time, but the outcome is the same: History will Rhyme.

I believe we are presently at such a Rhyming Point.  

To demonstrate my thesis I created a monthly log chart of S&P 500 and added 5 and 10 year moving averages (blue, red lines).  Breaches of the MA lines are rare, particularly of the 10-year.  It takes a lot of excess, indeed, to create the need to reset to such a large extent.

In the last 50 years there have been only 3 such events: in 1974 inflation was roaring due to the oil shock and President Nixon resigned in disgrace. In 2001 the Dotcom mania bubble burst spectacularly and in 2008-09 the Great Credit Crisis brought the entire global financial system within a hair of total collapse, saved only by the massive intervention of central banks which bailed out the private sector.

S&P 500 Monthly Log With 5 And 10 Year Moving Averages

What about today?  The COVID crisis prompted governments and central banks to create unprecedented amounts of QE cash (aka debt) to be distributed to everyone willy-nilly (aka helicopter money).  The immediate result of QEmax was an enormous bubble in everything from stocks, bonds, real estate and commodities, all the way to loony stuff like meme stocks, cryptos, SPACs and NFTs.  Shortly thereafter we got consumer inflation rising at the fastest pace in 40 years.

Has the excess been corrected? To some degree yes, but certainly not enough and certainly not in everything.  The loony stuff has been first to come down, as it always does, but the "core" excess is still very much with us.  Large cap stocks, long bonds, real estate, consumer spending and the labor market are still flying high, by historical norms.  For example, S&P 500 is nowhere near its 10-year average (currently at 2.655), never mind breaching it. 

Interestingly, the Fed has completely changed its tune when it comes to markets, but markets appear to be ignoring it.  In yesterday's minutes' release the Fed goes out of its way to underline its resolve to keep rates high for as long as it takes to bring inflation down to 2% or less.  Yet, markets don't seem to care.  Why?

Here's what I think: investors/speculators believe that rates have come up so much and so fast that a significant recession is a certainty, and that the Fed will thus be forced to quickly reverse its monetary tightening, probably within a couple of months. Wrong!  Consumer demand is strong, the labor market is strong (wages are rising fast, too) and inflation is transitioning from goods to services.

The Fed cannot afford to blink: with debt/GDP at record highs the US simply cannot afford high inflation and high interest rates.  The Fed MUST kill inflation - period.  And it will certainly err on the side of too tight instead of loosening too soon.  It is still, in some ways, still too loose: there is just way too much cash still sloshing out there (just look at the O/N reverse repo!) and it is not being absorbed fast enough to make a serious dent on inflation.

Bottom line: There is still too much excess out there and it WILL correct. Again.

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