Have you noticed the markets seem pretty risk-on lately?
It's not just that the Nasdaq, the worst of the major indexes last year, is on track for a four-day win streak. You've also got copper--a leading global indicator--back to its highest levels since last June. Oil has rebounded to over $75 a barrel. The "FANG+" proxy, the FDN ETF, is up for the eighth time in the last nine trading days. Even crypto and meme stocks are flying!
So we can chuck all that recession talk, right? I wish. Instead, it's going to be a long year of bracing for a bigger macro downturn--which may not even fully hit until 2024--while wondering whether to pile into some of these last-gasp trades. Could you even have positive risk-asset returns going into a recession? Sure! Would I want to play that timing game? No, thank you.
For starters, let's remember that this latest risk-on bout seems triggered in part by falling bond yields. Ah, yes, back to those good old days. But these falling yields are "no bueno." They're dropping because markets see the slowing growth momentum in the economy. The 10-year yield has dropped from roughly 3.9% to nearly 3.5% just since January 1; this trade lately feels like the flip-side of that.
The dollar has weakened, too, which tends to prop up prices of copper, oil, and anything else priced in greenbacks. Same story for the recent run in emerging market stocks, which love a weaker U.S. currency. Is China's reopening part of the story? Certainly, but few think it can fully offset slowing U.S. growth this year.
In fact, this risk-on bout may even trigger the return of the bad old days of rising oil prices, which could hasten the U.S. consumer pullback. I don't like seeing an oil investor as smart as Pierre Andurand tweeting that oil could have significant upside this year before it collapses. We all remember 2008, when oil prices first spiked all the way to $140 in the late spring before collapsing to below $50 in the fall after the financial crisis climaxed.
Could this resemble 2008 in another aspect? As late as June of that year, people were arguing that the economy wasn't that bad (I remember because I wrote the article about it). Perhaps we had dodged the downturn that the 3-month/10-year yield curve warned about! After all, it hadn't been negative in over a year at that point (it was inverted from late 2006 through mid-2007).
Alas, that was not to be the case. We turned out to be three months away from the collapse of Lehman and AIG that ushered in the financial crisis and decade-plus of sluggish growth. So even if the yield curve turns positive this year because the Fed finally gets more dovish or whatnot, it will be hard to feel truly at ease with what's lurking around the corner.
What's more, the Fed will see rising stock prices as loosening the very financial conditions they are trying to keep tightening. Such a rally on their expected dovishness could actually make them less dovish, and therefore worsen the longer-term growth outlook! This "hawkish Fed loop," as Deutsche Bank's Torsten Slok calls it, "is limiting how much equity and credit markets can rally over the coming months," he warns clients. In other words, he says, don't fall for the headfake.
See you at 1 p.m!
Kelly