Here at Southbank Investment Research, we constantly debate the state of the economy and financial markets. Yes, we also discuss the upcoming football, rugby or cricket fixtures, and I’m pleased to say that we disagree about all of the above with comparable vigour.
I’m pleased because disagreement is an important source of insight. It is through debate that we learn from where ideas originate, whether and where they overlap, where and how they diverge, and why.
All investment processes begin with idea generation. Risk management is essential to be sure, but without ideas, no risk is originated in the first place.
The ideas we put in front of you, our subscribers, have withstood a healthy degree of internal scrutiny, sometimes a great deal. We are one another’s harshest critics at times.
It is rare indeed that most of us line up behind a big idea. There are a few, however, such as our view in 2021 that inflation would soar; and our view in 2022 that there would be a “pivot” from alternative back towards more traditional sources of energy
We don’t get all the big calls right. But those are two recent, high-profile wins for us.
In recent weeks, we’ve been zeroing in on another: the global economy appears to be rolling over into recession.
The pieces have been in place for months. Money supply growth has plunged over the past year into deeply negative territory. Liquidity conditions have tightened considerably, taking out several US banks in the process.
Housing markets have seized up on both sides of the Atlantic. Mortgage rates are resetting higher. Offers are being pulled. Things are deteriorating, rapidly.
One of the best leading indicators for global economic activity is US capital goods orders. Capital goods are the “muscles” of the economy. They do the heavy lifting.
When the “blood” – liquidity – of the economy stops flowing, it is usually only a matter of time before the muscles stop functioning. That time appears to be now. US capital goods orders have been weak for several months now, especially when viewed in inflation-adjusted terms.
Depending on which definition of recession you choose, it could be that the US has now entered one. China is also clearly slowing down. Europe lacks any domestic growth impulse.
Inflation is beginning to come down, yet central banks have yet to ease policy. Even if they begin to soon, the effects of rate cuts would take months, perhaps over a year, to have a supportive effect on economic growth.
If the global economy is indeed rolling over, why has the stock market been rising? Well, if you look at so-called “internals”, it looks weaker. Cyclical stocks are underperforming non-cyclical. And if you strip out big tech and artificial intelligence (AI) stocks, the overall market has been trading poorly.
While it is possible that AI, energy and a few other areas may retain some positive impulse ahead, the broader market is probably now headed lower, perhaps sharply so.
Defensive investors might be tempted to flee into cash and bonds. That’s certainly tempting, but as I have written on numerous occasions, cash is guaranteed to lose real purchasing power in an inflationary environment. And bond yields may be higher than they were, but are generally still trailing inflation.
My preferred defensive strategy remains to overweight those sectors with low but generally stable profit margins and to hold a substantial portion of my portfolio in gold and/or precious metals mining shares.
In a stagflationary environment, gold behaves as a more defensive asset than either cash or bonds. And precious metals miners are currently trading at low valuations relative to their own history and to the broader market.
Until next time,
John Butler
Investment Director, Fortune & Freedom
PS If you’d like to comment on this edition of Fortune & Freedom, please send me an email at [email protected].
