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Written by: Tim Pierotti
One of my least favorite former bosses (competitive category – maybe it’s me) liked to say, “Markets don’t lie, people do”. He was a portfolio manager, and I was one of the many analysts who had to suffer this little pearl of wisdom every time we made the case that a particular stock was behaving in a manner inconsistent with the fundamentals as we saw them. In other words, he was saying a stock, or an entire market’s direction is always right and always instructive of the future. Well of course, that isn’t correct. Markets are not perfectly efficient. If they were, stocks would never crash, and government bonds would never have the kinds of violent swings we have witnessed in recent years. As Keynes famously said, “The market can remain irrational longer than you can stay solvent.” Further to that point, Stocks, Bonds, Oil and Gold are all massive and liquid markets that should impart some directional wisdom, but currently, the messages they are sending are not just inconsistent, but contradictory. It is not every day that Wall Street is forecasting faster earnings growth while Fed is lamenting the downside risks to employment. Let’s run through the disparate wisdom of each one.
The S&P hovering around all-time highs is saying that growth is accelerating and so are margins. Price-to-Earnings ratios are at historically high levels, as are margins. Wall Street is estimating that the good times get better forecasting that profit growth will accelerate to more than 10% growth in 2025. Inflation will fall back to the ever-quiescent harmlessness of this century’s teen years, but consumer and industrial demand will grow stronger in the second half of this year and next. Despite the lack of return on the many billions of spending on AI, there is no cooling of the optimism that a new era of productivity growth is upon us. Our take is that the risk/reward in equities is poor. Earnings growth will correlate with Nominal GDP growth and that is slowing. Multiples will likely be challenged by increasing inflation volatility.
Corporate bonds and spreads (the yield in excess of Treasuries) are largely telling the same optimistic story as equities. At the very least, the strength of the corporate bond market is saying that no recession is at all imminent. On the other hand, The Federal Reserve has telegraphed to markets that they see the risk of a recession as growing so the front end of the yield curve is pricing in roughly six cuts over the next year. Given the Fed has never cut by more than 75bps outside of a recession, I think we can safely say that shorter maturity treasuries are pricing in a recession. The Ten-Year, like the Two-Year, has moved up (Yields down) substantially, but not nearly as much and, as a result, the inverted yield curve has “disinverted”, which has historically been a pretty good indicator of recession. Our take is that the higher Ten-Year yields may be telling us that the war on inflation has many battles yet to be fought and that US fiscal deficits are starting to matter. The Ten-Year is not yet pricing in a hard landing (deep recession) or long-term drop in demand.
Oil is interesting in that physical reserves are tight globally, but market participants also know there is plenty of spare capacity being held offline by the Saudi’s. Demand is currently solid, driven as usual (as always heretofore) by emerging markets, but financial participants in the oil market (speculators) continue to largely bet against a global demand recovery and are betting that oil prices drift lower from here. The worsening economic situation in China is central to global demand growth bearishness. Our take is that oil is reflecting a steady state of growth and supply and the $75 - $80 WTI price reflects a world that isn’t falling into recession, but certainly not reaccelerating. There is clearly some geo-political risk, or increased sensitivity, priced in to oil as we see moves up through $80 when the saber rattling gets loudest and back toward $70 when it fades.
Gold is on fire, up over 22% versus the US dollar in 2024. Gold is saying that there actually is an alternative to the US dollar and dollar denominated assets. No, of course, it isn’t the Euro or the Yen and certainly not the Yuan. It is gold. Gold is being bought en masse by retail buyers in China to protect against Yuan devaluation. Gold is being bought by central banks as a dollar diversifier. The strength of gold is telling us that the global money printing cycle has consequences and that growing sovereign debt loads tend to beget the inevitable perpetuation of more inflationary policy. Gold is telling us that inflation isn’t dead. We agree.