It wouldn't take much going right to turn things around. Less wrong would likely be good enough at this point. Or maybe even just different wrong. Like, just as the market has everyone worried about inflation, it pulls back the curtain and shows us with a flourish that it’s really deflation we should be worried about.
Markets love to climb a wall of worry, and that wall is looking extraordinarily high at the moment: inflation, recession, war, food shortages.
Is everything priced in yet? Probably not. But I think it’s at least time to start looking for signs that something could go right. Or less wrong. Or different wrong.
Let’s see if some charts can help us keep a lookout.
Is inflation not as complicated as we think?
History suggests inflation is mostly just a function of oil, which suggests that for inflation to go down, oil only has to stop going up. That can’t be so hard, can it?
It might be different this time:
The focus on ESG may keep oil higher for longer: The CEO of Chevron recently said he doesn't expect a new oil refinery to EVER be built in the US again. But at least some supply response is happening: Oil rig counts are rising.
Inflation is different this time, too:
Demand for goods (blue line) shot higher in the pandemic and demand for services (red line) slumped. (You knew that already, but, still, amazing chart, right?) The inflationary impact of that unprecedented happening is still working itself out — but these two lines will eventually start to converge.
Financial tightening may be further along that you think:
US mortgage rates nearing 6% will take housing prices off the boil. (Although, it’ll be some time before that feeds through to headline CPI, which is what the Fed worries about, per Powell’s comments this week.)
The Fed is telling us not to spend, and we’re listening:
The velocity of money got crushed in the pandemic, which was unsurprising, but did you expect it to stay there?
Retailers did not…
… and they have been stuck with a lot of inventory (only partly for that reason), which is helpfully deflationary.
GDP expectations are deflating as well:
A 0% (or worse) GDP print would shift the focus from inflation to deflation. Which means it’s time to start worrying about earnings.
But maybe we already have?
The Russell 2000 index of US small caps (more representative of the economy than the S&P 500) trades on less than 10x forward earnings, excluding loss making-companies. (Which we exclude, because even loss-making companies can’t be worth less than zero). So, I’d say the market is already bracing for recession.
That is something to worry about. But at least it’s something new to worry about.