- Fixed Income Portfolio Manager
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain
It is striking to me that a mere seven weeks ago, virtually everyone seemed sure that the financial system was healthy and that most US banks had plenty of capital. Obviously, the March 2023 failures of Silicon Valley Bank (SVB) and Credit Suisse have highlighted the potential risks of such market complacency.
In that vein, I’ve identified what I see right now as three entrenched macro assumptions that could well turn out to be wrong – ideas that, to paraphrase Mark Twain, “the market knows for sure that just ain’t so.”
This widespread belief is a relatively new one. Prior to 2022, most economists would have said that the US Federal Reserve’s (Fed)’s biggest challenge was guarding against disinflation. These days, however, many doubt that the Fed will be able to bring inflation down to its 2% target anytime in the near future.
I agree with the long-term structural arguments for higher inflation resulting from deglobalization, but contrary to most observers, I believe the real problem over the next year could actually be that the Fed misses its inflation target to the downside. Certainly, the Treasury Inflation-Protected Securities (TIPS) market embraces this possibility, with forward-inflation expectations recently below the Fed’s 2% long-term target (as measured by the Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge).
Why the disconnect between market consensus and my own view? Bank lending, which is the most high-powered form of money (and thus most closely related to money velocity), is likely to slow amid today’s tighter credit conditions following the turmoil in the US banking industry (Figure 1). If that proves correct, why wouldn’t we expect inflation to cool and even surprise meaningfully to the downside?
Many investors believe the US corporate sector is quite healthy, with strong balance sheets, stable leverage ratios, ample interest coverage, and robust free cash flows. The latest data supports this belief, and many companies did use the low-rate environment of 2020 – 2021 to term out debt. However, much of the available free cash flow can be traced to a lack of capex investment over the past decade, plus companies holding off on further spending until inflation ebbs. Can companies continue to focus on debt-financed share buybacks in lieu of capex in a deglobalizing world of higher rates? Unlikely.
Most investors look at BBB- rated companies with roughly 3x leverage and net-debt-to-enterprise values of 33% and see no reason for concern. However, our research suggests that corporate profits could fall 15% – 25% during the next recession. If multiples were to contract similarly, then your typical BBB- company would start to look more like a BB- risk. For high-yield companies, this math would be even worse.
Normally, companies do not undergo stress from too-high interest payments or because they can’t roll over principal payments; more often, their net debt/enterprise values get so high that they find it easier to restructure the debt. Could ratings downgrades and economy-wide defaults surprise meaningfully to the upside? Perhaps.
This is something the market has been lulled into believing, as the 15-year US dollar (USD) bull market may have ended in September 2022. The USD has historically tended to move in such long cycles, but often with little correlation to equity performance and market volatility. Past examples of USD underperformance despite financial market weakness include the 1970s, Black Monday (1987), the 1994 Fed hiking cycle, and the bursting of the tech bubble (2000).
Figure 2 shows the performance of developed market (DM) currencies and emerging market (EM) currencies during periods in which the S&P 500 Index suffered a drawdown of 15%+. Prior to the global financial crisis, in most cases, the USD actually underperformed other DM currencies in risk-off environments. EM currencies have a more mixed track record.
The USD has been curiously weak during and since the SVB fiasco. Maybe the pandemic-induced fiscal spending and debt-fueled asset bubbles are starting to catch up to the greenback.
Three themes (and what they mean) for income investorsContinue reading
How to interpret the Bank of Japan’s latest policy shiftContinue reading
A test for the global economyContinue reading
2023 Mid-year Investment Strategy OutlookContinue reading
How to weather the storm: A roadmap for more resilient portfoliosContinue reading
Multi-Asset Outlook: A recession is looming…or is it?Continue reading
How a thematic approach can help harness change within portfoliosContinue reading
Three themes (and what they mean) for income investors
With several macro crosscurrents at play, Portfolio Manager Peter Wilke suggests that income-oriented investors not lose sight of the “big picture” in their quest for yield.
How to interpret the Bank of Japan’s latest policy shift
We analyse the wide-ranging investment implications of the Bank of Japan's latest policy shift.
A test for the global economy
What are the similarities and differences between the US regional banking crisis and 2008's global financial crisis? How likely is a recession? Should investors be focusing on value or growth? In this podcast, Macro Strategist Nanette Abuhoff Jacobson shares her interpretation of where the economy is headed, outlining where the risks and opportunities may lie for investors in the next 12 months.
2023 Mid-year Investment Strategy Outlook
To help think through the asset allocation outlook and implications for 2023, we offer views from iStrat, our investment strategy and solutions group
How to weather the storm: A roadmap for more resilient portfolios
As we face a new era of elevated market and cycle volatility, Co-Head of Investment Strategy Natasha Brook-Walters assesses how asset owners can ensure that their portfolios are up for the challenge.
Multi-Asset Outlook: A recession is looming…or is it?
The economy has largely shrugged off the banking crisis and other concerns this year, while riding positive sentiment driven by AI enthusiasm and a possible soft landing. Members of our Investment Strategy team offer their macro and market outlook for the second half of the year, including their latest views on equities, bonds, and commodities.
How a thematic approach can help harness change within portfolios
Multi-Asset Strategist Supriya Menon and Investment Director Andrew Sharp-Paul discuss why a thematic approach can help harness change within portfolios against a structurally different macroeconomic backdrop.
Is your asset allocation ready for the realities of climate change?
Our Investment Strategy Team shares key findings from the research behind their climate-aware strategic asset allocation (SAA) approach, including challenges and trade-offs that asset owners should understand.
Focus on what you can control: Five alternative investment ideas for an uncertain world
Multi-Asset Strategists Nick Samouilhan and Adam Berger explain how a variety of alternative investments, including select hedge funds and private credit, could help allocators reduce the importance of the economic cycle to their portfolio results.
Mid-year Investment Outlook
Explore our latest views on risks and opportunities across the global capital markets as we look ahead to the second half of 2023.
Asia: A growth story with longer-term momentum
Is China’s recovery already running out of steam? Macro Strategist Santiago Millán assesses the outlook for China and Asia and sees longer-term momentum for growth.