The stock market is wishing and hoping the Fed will pivot — but the pain won’t end until investors panic

The new year ushers in optimism about a more modest decline than previously anticipated and lower price pressures. This has led to a boom in the asset markets. Even previously destroyed cryptocurrencies and unpopular tech stocks have rallied.

Market pros are so bullish on stocks right now, you wonder if they’re too bullish

The bullishness is underlined by four “P” words: peak (on the assumption that inflation is reversing); stop (the rate hike will stop soon); pivot (cut later in 2023), and put (central banks will continue to drive down equity and real estate prices to avoid destabilizing the financial system).

There’s one caveat to this rosy forecast: “Damage.”

Core inflation (currently running at around 5%-6%) is unlikely to fall to the central bank’s target (2%-4%) for some time. Prices, especially of essentials (housing, food and energy) will remain high for a number of reasons.

The real driver of inflation – supply issues – remains unchanged. The scarcity of labor markets and wage growth will flow into prices. The Ukraine war is showing no signs of resolution. The effects of increased cooperation between Saudi Arabia and Russia on the West’s oil price cap and energy markets are unknown. Despite the easing of controls, the impact of COVID-19 on sugar production remains uncertain.

In addition, longer-term factors – including geopolitical events (sanctions, trade restrictions), resource scarcity, climate change-induced extreme weather events that affect food and transport links, and globalisation, particularly reshoring or “Friend-shoring” – will also increase costs.

The fiscal lapses of the government are also continuing. In the US, for example, the 2021 US rescue plan and the US Inflation Reduction Act, combined with substantial cost of living and energy subsidies in advanced economies, will boost demand at a time when economies lack excess productive capacity. A sugar recovery, central to the upward revision of growth estimates, could also propel commodity prices.

Investors’ palpable faith in central bankers accurately reading events and implementing policies can be misguided. It is worth remembering that these same officials failed to act in time because inflation was “fleeting”, their belief that higher rates could fix supply-side problems, and current asset prices with lax monetary policies Make bubbles. There is a possibility of policy lapse.

Three additional ‘P’ words may be relevant for investors in 2023:

Permanence: Prices can be high. Interest rates may increase further. Central banks may have to be more aggressive than expected. Rates may remain elevated (by recent standards) for longer than expected. Real price growth coupled with wage growth, reductions in disposable income and discretionary spending can slow economic activity.

Reports of US job losses three times stronger than they actually appear

This will exacerbate the effects of already slowing consumption, which was financed by additional savings in 2022 (G-7 households set aside nearly $3 trillion or about 10% of annual consumer spending from pandemic stimulus and lower outlays in 2020-21 was stored).

Pain: The longer-than-expected duration of higher interest rates will test the debt repayment capacity of both governments and households (mortgage loans). In Europe, sovereign debt remains high in France (government debt at 113% of GDP), Greece (193%), Italy (151%), Portugal (127%) and Spain (118%). Higher borrowing costs and fewer debt purchases by the European Central Bank could spark a rekindling of the unresolved European debt crisis of 2009. Highly indebted emerging markets are facing a financial crisis. The loss will affect both banks and investors.

Other concerns include the opaque, large shadow banking system, highly inflated valuations (despite some retracements), and the highly leveraged transactions that have proliferated during the past decade. The problems with ArcGos and the UK’s debt driven investment scheme highlight the hidden risks that could emerge.

‘Nasdaq is our favorite short.’ This market strategist sees a recession and a credit crunch slamming stocks in 2023.

values ​​of Private Market Unlisted Investments , to which institutions and high net worth individuals are increasingly exposed, has not, to date, reflected the decline in public market prices. Given that these often highly leveraged holdings are hit by higher rates and will eventually need to be priced against a public benchmark, the unpleasant write-down would not be surprising.

anxiety: The potential for asset holders to have a prolonged period of high rates and weak growth remains an unknown. As history shows, falling prices, margin calls, forced selling as investors seek to generate cash, illiquid markets, suspension of redemptions and declining credit availability can fuel increasingly negative financial cycles.

In the final analysis, it is difficult to see how a highly leveraged system dependent on low rates and abundant liquidity could easily and painlessly adjust to a world facing multiple challenges. multi crisis, Replacing the magical thinking of the last decade with wishful thinking would not serve investors well.

Satyajit Das is a former banker and writer A Feast of Consequences – Reloaded (2021) and Fortune Fools: Australia’s Choice (March 2022)

More: Jobs report tells markets what Fed chief Jerome Powell is trying to tell them

Too ‘It’s time to repay.’ US stocks have been no-brainer money makers for years — but those days are over.