Helter Skelter

What thrills and spills await this week? Last week, as you presumably already know, stock markets enjoyed a brief rally that was canceled out within hours, the dollar continued to strengthen, and bond yields kept on rising (with the benchmark 10-year Treasury yield passing 3%). All of this was against the backdrop of a welter of macroeconomic data, corporate earnings results, and central bank policy announcements that were conspicuous for their lack of major nasty surprises.

What changed? As we brace ourselves once more, here are some of the more important trends — and trend reversals — that are slightly further below the radar.

Value Really Is Winning

The wait for the value factor (buying stocks because they’re cheap) to start outperforming the growth factor (buying stocks because their earnings are growing) has been going on about as long as the wait for Godot. But there is an increasing sense that the big growth stocks are exposed to higher interest rates, because more of their value is tied up in the future that must now be discounted at higher rates.

So far this year, Bloomberg’s estimates of returns that can be attributed to different investment factors within the universe of all U.S. stocks show that value has dramatically led the field. Dividends, generally regarded as a subset of value, came in second. Meanwhile, the volatile growth stocks with an intense trading activity that caused so much excitement in the first year or so after the pandemic struck are having difficulties. I’ll admit I expected this to happen a while ago, so I can’t say I told you so — but the value is, at last, having its day:

Looking at the most influential indexes of value and growth stocks, which will tend to show the factor effects more strongly, we find that in both the developed world as a whole (as measured by MSCI) and in the U.S. (as measured by FTSE Russell indexes), value has now broken out to its highest level compared to the growth since the Covid shutdown. This follows several incidents in which it had come close to doing so but retreated:

The market rotation is now well advanced, but should have further to go. It’s a fair bet that flows into value stocks will intensify from here, now that they’re viewed as shelters.

Peak Inflation

Barring a big surprise, the headline rate of U.S. inflation will have been lower in April than it was in March. Even the highest forecast submitted to Bloomberg’s regular survey is predicting a decline. Thus there is hope that the high point for inflation has at last been reached:

One supporting piece of evidence for a peak in inflation came as part of Friday’s non-farm payroll report, which was broadly in line with expectations. Average hourly earnings growth ticked down very slightly, prompting hopes that a wage-price spiral can be averted:

It’s still possible that a surge in wages that pushes up prices can be averted. These data don’t help establish that. First, there was a concerning decrease in the participation rate — the proportion of the population making themselves available for work — so the “Great Resignation” has not yet been plainly reversed, and the low supply of labor may continue. Beyond that, average earnings growth remains elevated by historical standards. The series was badly distorted by composition effects at the beginning of the pandemic (low-waged people were most likely to be laid off, meaning that average earnings artificially rose), and it’s still less than 12 months since this effect passed out of year-on-year comparisons. If we look at a six-month rolling average, however, it’s still rising.

So, pressure from the labor market may be starting to ameliorate, but it’s way too soon to say that with any confidence. The wage-tracker data from the Atlanta Fed, based on census figures, will be available later this week and should give valuable extra clues.

Commoditize This

Another reason for optimism about inflation is that commodity prices might be beginning to turn. The most realistic hope for this is in industrial metals, which received a massive boost in the first few days of Russia’s invasion of Ukraine. They’ve given up those freak gains while the slowdown in activity in China, exacerbated by Covid-zero shutdowns, has brought down the demand for metals there, as most often illustrated by the Qingdao iron ore benchmark:

And then there is oil, whose price has consolidated somewhat since the shock of the invasion. The politics of Europe’s attempted oil ban will continue to drive crude prices — but it’s concerning those gasoline futures, which fell with crude as the war in Ukraine continued, have surged to set a new high by the end of last week. Prices charged at the pump, are critical for the political scene, and the headline consumer price index, dipped very slightly last month, which adds to the confidence that the peak for inflation is in. Another leg upward would dismay the optimists:

The commodity market is a real-time attempt to assimilate geopolitical developments, growth fears, and shocks to supply and demand, so it’s an important place to look for the next few weeks. In particular, industrial metals like copper give great early warnings about how fears of weakening growth have developed (particularly in China), while oil is an early alert for supply shocks, as illustrated neatly in this chart from Standard Chartered PLC:

Even if this week does see the peak of inflation, however, there are more important issues. Inflation is at present far above any level that a central bank can tolerate for long. The Fed and other central banks need to see a swift decline, and not just a peak, before they desist from their current aggressive path of rate rises. If the headline rate has dipped to 5.5% by year’s end, for example, that would be significantly lower than now, but would mean that the Fed’s medicine wasn’t working well enough.

One final point on inflation — it’s very, very rare for an inflation reading to exceed the highest estimate that any economist has submitted to Bloomberg, but that happened three separate times last year. In the unlikely event that inflation keeps rising, markets will have great difficulty swallowing it.

Pensions

It’s an ill wind. There are few examples of genuine good news to come out of the inflation scare, but the improving health of pension plans bucks the trend. Last month was historically terrible, with both stocks and bonds falling. But lower bond prices make it cheaper for pension fund managers to match their liabilities. According to estimates from actuaries at Mercer, the effect of higher bond yields last month more than canceled out the effect of lower share prices for pensions’ portfolios, and their financial position strengthened. After more than a decade of persistent deficits, the assets of the defined benefit plans managed for S&P 1500 companies are now 1% bigger than their liabilities:

The inflation shock has allowed pensions at last to recover from the effects of the Global Financial Crisis. This development means a sharp reduction for the risks of an oncoming social crisis as companies declare bankruptcy to shield themselves from pensioners, or retired people go without income. That’s unambiguous good news.

It also conceivably may help the system adjust. If pension managers can match their liabilities with yields at their present level, they have a huge incentive to buy bonds. Yes, yields might rise still further, but the opportunity to be able to finance their pension guarantees with certainty may not come again. They should at this point become a much more active source of demand for bonds. In that way, they can provide a balancing mechanism.

There’s another way to look at this. The regulatory pressures on pension funds, insurers and others to buy bonds are often classified as “financial repression” — forcing savers to lend to the government at uneconomic rates. But the improving health of pension plans is a genuine reason to be cheerful.

Survival Tips

Revenge is sweet, but it’s best served a little more quickly than in 39 years. Back in 1983, Brighton & Hove Albion got to the FA Cup final for the first and still only time in their history, where they met the heavily favored Manchester Utd. They drew 2-2, with Gordon Smith failing to get the ball past Man U’s goalie Gary Bailey in the last minute of extra time for what would have been a famous victory. Five days later, they met for the replay (this was in the good old days when they took the Cup seriously and didn’t resort to penalty shootouts), and Man U won 4-0. Brighton were relegated, not to reappear in the top flight for 34 years; Man U, as almost all of you probably know, did really rather well in the intervening years.

So, Saturday brought Man U to play Brighton, needing a win to keep alive their slim chance of playing in Europe next season. Cristiano Ronaldo was among their star-studded lineup. Brighton won 4-0. And it could have been about seven or eight, as many United fans irately pointed out on social media. Watching this was rather like being force-injected with helium. What fun. What fun.

Rooting for normal no-hoper teams does have the big advantage that you appreciate the good times when they finally arrive. Knowing they may not come again, you make the most of them. For me personally, England’s 5-1 victory over Germany in 2001, in Munich, comes into a similar category. So does England’s ridiculous comeback to win the 2019 Headingley cricket test against Australia; and the epic victory of the Red Sox over the New York Yankees in the 2004 American League Championship Series, still the only time a team has come back from 3-0 down to win a seven-game series in baseball.

Seize on to moments like this and you can live through frankly awful passages of play, such as the Red Sox’ currently pitiful run of 12 losses in the last 15 games. Moments like this make all the pain worthwhile. Keep repeating that to yourself. And have a great week, everyone.

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