Commentary on Political Economy

Tuesday 19 October 2021



A Repetitive RIF

There’s no direct link in real time between the growth of the economy and the growth of the stock market. (There’s a very strong link over the fullness of time, but in the long run we’re all dead, as someone once said.) If you ever needed proof of this, it came Tuesday. The latest GDPNow index from the Atlanta Federal Reserve suggests that the U.S. economy is now growing at an annualized rate of barely 0.5%. The “reflation trade” and “post-pandemic boom” that we were all looking forward to have been deferred:

This number won’t have come as a surprise to the world’s money managers. The latest Global Fund Manager Survey from BofA Securities Inc. is available, and shows a sharp shift in sentiment. A few months ago, fund managers were expecting an “inflationary boom,” with both growth and inflation well above average. They still expect the inflation, but are no longer so optimistic about the growth:

All of this is happening against a background of a growing, if grudging, acceptance that the Fed will be raising rates over the next year. As the Bloomberg WIRP function illustrates, two hikes by the Fed’s meeting in January 2023 are now fully priced in:

Illustrated differently, this is the implicit path of the fed funds rate until that January 2023 meeting. The conversation has well and truly moved on from tapering and quantitative easing. The question is now all about the old-fashioned issue of how far interest rates will rise and how quickly:

This sounds like a horrible environment for investing in equities. And yet, the S&P 500 nearly got back to an all-time high Tuesday. Comparing stocks to bonds using my favorite simple measure, the ratio of the “SPY” and “TLT” exchange-traded funds, respectively tracking the S&P 500 and Treasury bonds of 20 years and longer, we find that stocks have broken decisively to the upside. This is how the measure has moved over the time that both ETFs have been available:

How to explain this? TINA (There Is No Alternative — to stocks), appears to have morphed into her fearsome sister TINA RIF (There Is No Alternative — Resistance Is Futile). With yields low and inflation on the horizon, bonds are regarded as unbuyable. The BofA survey finds that more asset allocators are underweight bonds than at any time since they started asking the question some 20 years ago:

It’s worth looking at how some of the previous extremes of pessimism toward bonds worked out. None were justified, as the steady historic fall in bond yields continued throughout. In July 2007, a run on Treasuries was the prelude to the unwinding of the structured credit market, and then the full-blown credit crisis. Bonds did well, while scarcely anything else did. The February 2011 scare presaged the crisis surrounding the debt ceiling and the Standard & Poor’s downgrade of federal debt — when it turned out that the best way to take evasive action was to buy bonds. In 2013, investors overreacted to the “taper tantrum” and life soon returned to normal; and in early 2018, fund managers’ pessimism was the cue for bond yields to provoke an outbreak of volatility in equities and, ultimately, to dissuade the Federal Reserve from pressing ahead with quantitative tightening. So it may not be safe to assume that bond yields are heading upward, but fund managers are more convinced that the trend is about to turn than they have ever been before.

It isn’t just fund managers. As demonstrated by this research from David Kostin, U.S. equity strategist at Goldman Sachs Group Inc., broad positioning in stocks as opposed to bonds and cash is at a historic extreme. This chart smooshes together holdings by households and foreign investors with those of U.S.-based institutions, and finds equity allocations have recently overtaken the all-time high set just before the dot-com bubble burst in 2000:

(As with the numbers on bond pessimism, it's worth noting what happened after the last such peak in equity weightings; it’s not necessarily a healthy sign.) That demonstrates the steady shifting of the tectonic plates in favor of the optimism that accompanies equities. For a more current number that demonstrates serious risk appetite, there’s bitcoin. 

We have just witnessed the second most successful ETF launch in history, of the first such fund based on bitcoin futures. I have turned into too much of a curmudgeon not to notice how painfully similar that sentence was to many I wrote 22 years ago as the first wave of internet speculation was cresting. History might not repeat itself; it just seems very likely to do so to someone who lived through the dot-com mania.  

My colleagues can tell you all about the 24 million shares traded in the ProShares Bitcoin Strategy ETF, which produced plenty of intrigue, and helped bitcoin reach yet another record. The new ETF, which can be traded 24 hours per day,  should in theory make it that much easier for a wider range of investors to buy into bitcoin, and the model could be extended to other cryptocurrencies. Many are impressed by the precedent of gold ETFs, whose arrival boosted the price and broadened the precious metal’s pool of investors. 

The excitement seems to be indicative of a mood across the market. Bitcoin hit a new high, and its surges since the pandemic have noticeably overlapped with ebbs and flows in bond yields. I’m not trying to say that it’s correlated with bonds; but moves in bitcoin are more clearly being driven by “risk-on” sentiment, and its ebbs and flows are now overlapping with belief in inflation:

What is strange about this, and disconcerting, is that the optimism is reaching these peaks in a situation where confidence in growth has declined, and fears of rising inflation and rates are back. Bonds indeed don’t look like a buy — but a lot is being built on the notion that they leave us no alternative but to buy something more risky. 




Mexico: A Difference of Opinion

Writing for Bloomberg Opinion carries the disclaimer that it reflects the views of the writer, not of Bloomberg. This means that columnists are free to disagree with each other. So, let me very respectfully, and regretfully, explain why I disagree with a column about Mexico by my colleague Tyler Cowen. Tyler has been visiting Mexico regularly for 40 years, and believes it’s ready for a period of steady and unspectacular growth, which could turn it into Denmark. I’ve only visited Mexico regularly for 25 years, but I did live there for four years, and like Tyler I love the place. It’s a wonderful country, much misunderstood and unfairly disdained by its neighbor to the north. But, sadly, I don’t buy that Mexico is ready for Scandinavian-style growth.

Tyler runs through many valid reasons for optimism. It’s next to the U.S., has a growing middle class, a great startup community, sensible economic leadership with impeccable academic credentials, a democracy that is slowly and painfully becoming more functional, and it naturally stands to benefit from any decline in U.S. trade with China. I have made many of these points myself. The problem is that most have been true for decades, and they haven’t helped Mexico to deliver for its population, or for foreign investors. This is Tyler’s conclusion:

Many investors and economists have been unduly pessimistic about Mexico because it has not grown at the pace of China. At this point, it’s best to concede that it probably never will. Yet many of the world’s more successful countries, such as Denmark, never had major growth spurts as China did. Instead, they managed a steady pace of growth with a few big dips.

Mexico, with its strong connections to the U.S., is well-positioned to achieve that kind of growth stability over the coming decades. Unlike in the 1980s, the Mexican central bank is run by well-educated technocrats. Even during the pandemic, which hit the Mexican economy very hard, credit ratings remained acceptable.

The problem isn’t so much that Mexico hasn’t grown as fast as China. After all, nobody has. And Denmark, a small and prosperous trading nation, has long had a more developed economy than Mexico’s. Danes were much wealthier than Mexicans 75 years ago, and they still are.

No, I suggest that if there is a fair comparison for Mexico, it is South Korea. And that is a painful one. Alternatively, look at Greece. Both countries had significantly lower GDP per capita than Mexico’s at the end of the war. Remarkably, even Japan was poorer than Mexico in the late 1940s. This chart, which I produced on Our World in Data, tells the sad story (for Mexicans) of what has happened since then:

South Korea, like Mexico, is a medium-sized country with an economy traditionally built around peasant agriculture. Like Mexico, it spent most of the post-war period under a relatively benign autocratic governmental system, shifting to a rather messy democracy in the last few decades. Like Mexico, its corporate sector is dominated by a few large conglomerates. Both countries endured massive financial crises in the 1990s. Both have a painful history of humiliation at the hands of more powerful neighbors. Both had big economies nearby with which to trade. And yet somehow, the relative wealth of the two has inverted since the war. In 1946, Mexican GDP per capita was more than triple South Korea’s; now South Korea’s GDP per capita is more than double Mexico’s. What happened?

Alternatively, how did Mexico slip so far behind Greece, another agrarian society (and another of my favorite countries) that has been over-reliant on tourism and generally suffered governance at least as corrupt? Unlike South Korea, Greece is nobody's idea of a great economic success story. But it’s still fared far better than Mexico.

If pressed, I would name two problems. First, education. Korea’s is ruthlessly efficient, producing generation after generation of great managers and skilled workers. Mexican education is a mess. An elite go to a few great universities at home, and then generally to the U.S.; broader education has far too many gaps. 

Second, there is the curse of resources. Mexico traditionally has a strong mining industry, and it still has a lot of oil. Successive Mexican governments have treated the state oil company as a “milch cow” that can support growth and sustain the state. South Korea (like Japan) has had to find a way to grow without such resources.

Could Mexico finally take off, as Tyler suggests? It could. Its progress has been slow and steady, but unmistakable for those who know the country. The middle class is growing, and wealth is spreading. But there is no particular reason to expect this now.

Judged as an investment opportunity, Mexico has done better than might be thought. Since the 1994 Tequila Crisis, in which a sudden peso devaluation triggered a banking collapse, Mexican stocks outperformed the rest of the world, and even the U.S., for more than a decade. But it has been lagging behind steadily for a decade now:

If there is a reason for optimism, it might be more old-fashioned. Mexico and other resources-led markets of Latin America have tended to rise and fall with commodity prices. Those in turn tend to gain during times of inflationary angst in the West. The region enjoyed an investment boom during the last bull market in metals. But, fascinatingly, the latest resurgence in metals has done Latin American assets no good:

There are many good reasons why Mexico should start to perform. But the greatest chance would lie in a return to the belief that the region and its natural resources offer a refuge in times of inflation. Its path to Danification isn’t an easy one.

No comments:

Post a Comment