The 12 Charts To Watch In 2022 – Half-Time Update

2022.06.27 10:31

Well there goes the first half of the year. Don’t know about you, and maybe I’m just getting old, but time seems to be slipping by faster and faster. Then again, maybe it’s just the unusual and challenging way that this year is unfolding across nearly all facets of life.

I’ll tentatively count myself among the few who managed to get it mostly right so far this year on macro and markets (I say tentatively: you never want to get too proud of yourself and pat yourself on the back with this business as it naturally leads to hubris/arrogance/complacency in what is a very competitive, complex, and unforgiving dynamic puzzle solving process).

But this does bring us to the point of this post: reviewing my “charts to watch in 2022” piece to update the thinking and reflect on initial thoughts at the start of the year.

So let’s get on with it…here’s a half-time progress check on the “12 Charts to Watch in 2022!” In the original article I shared what I thought would be the 12 most important charts to watch for multi-asset investors in the year ahead (and beyond).

In this article I have updated those 12 charts, and provided some updated comments on the outlook—given the dramatic shifts seen during the first half of the year.

1. Fed Behind The Curve: Despite increasingly aggressive moves (+25bps in March, +50bps in May, +75bps in June…and, pattern recognizers: JP has said 100bp moves are not off the table!!), the Fed remains behind the curve on inflation. While you might argue some or even most of the current inflation is down to supply-side issues there are 2 things to remember:

1. Supply issues disappear if demand disappears; and 2. The risks are not so much in today’s inflation, but in the prospect that a surge in inflation triggers an inflation expectations spiral where the expectation of higher inflation becomes a self-reinforcing, self-fulfilling feedback loop.

But above all, as noted, the Fed made its bed when it chose to avoid the risk of tightening too early—and perhaps even in going too hard on stimulus in the first place. In that respect, the forces set in motion in 2020 are simply coming full circle.

Inflation Expectations vs Fed Funds

2. Fed Catch-Up Risk: Fed catch-up risk has become Fed catch-up reality. The harder they hike, the more likely it is that something will break. In the extreme, the only way to really well and truly get inflation under control is to trigger a recession, and as I detailed in a recent webinar, recession is basically now the base case.

Credit Spreads vs Fed Funds Rate

3. Growth Scare 2022: Change that to “Recession 2022″—cost pressures (energy prices, general cost of living increases), surging mortgage rates, tightening lending standards and credit markets, falling asset prices, rate hikes, fiscal drag, COVID resurgence, war, and the kitchen sink…all signs now point squarely in one direction. The bulk of my leading indicators now say recession is near-certain, likely to kick-off in H2 and carryover into 2023.

OECD Leading Indicators

4. Corporate Capex: Even capex can’t save the day, an initial cyclical rebound looks set to cap-out and rollover based on the capex leading indicator.

While some of the medium/longer-term themes likely continue (e.g., commodity capex, shipping capex, climate/EV related, space age 2.0, etc.), the cyclical outlook for capex is clearly less certain, and it seems unlikely that any lift in capex will be enough to offset the looming economic headwinds.

Capex Outlook

5. Capacity Utilization: Oh and back on inflation, here is a fundamental, non-transitory reason why inflation pressures are serious and why central banks should be taking it seriously. Labor market capacity utilization is basically record tight.

Even industrial capacity utilization is tight…and probably would be tighter if supply-chain issues were completely resolved. Either way, this goes to show the real underlying impetus on inflation (and perhaps one reason for firms to push on with capex).

Developed Economies Capacity Utilization – No Output Gap

6. Government (and Green) Capex: If this year has taught us one thing it is the cost of cheap talk from governments and activists about going to zero carbon. You can’t sprint into a post-fossil-fuel world without taking massive action; without investing on an unprecedented scale…nothing short of a new Manhattan Project style mobilization is required if you *really* want to get it done.

There is a great leap, a grand chasm, between where we are and where the grand energy utopia promised lands lie. For what it’s worth, I think we probably throw everything at it, make it happen, fully mobilize.

But the key point is that all this talk and virtue signaling—which is now a popular and mainstream thing that requires no courage and represents zero uniqueness—needs to be backed by actual action. This is why cheap-talk is expensive, and one of a few reasons for pain at the pump.

But anyway, the original idea here and with this chart was that governments would embark on climate related (*and infrastructure*) investment. And there is certainly some stuff in the pipe—especially globally, but clearly original plans in the US failed, and now distractions and disarray mean this one is a wash.

US Government Fixed Asset Investment Infrastructure Capex

7. US Absolute vs Relative Valuations: Over to markets, this chart has changed a lot—absolute valuations have come down significantly but-1: still not cheap; and but-2: the ERP is still expensive as bond yields have drifted higher.

Indeed, at this point I look at treasuries and on my model they look slightly cheap, whereas equities still look slightly expensive…TINA [there is no alternative (to stocks)] >>> TADA! (there are definitely alternatives).

S&P 500 Valuations Vs History

8. US Asset Class Valuations: This one has also changed quite a bit, of most intrigue is that my commodities valuation indicator has just edged out equities for second place on the pantheon of preposterous prices (I… apologize for those words.).

But again, as alluded above, bonds are now slightly cheap, but meanwhile on P’s…property is off to Pluto.

Asset Class Valuations vs History

9. US vs Global Equity Valuations: Back on equities, things change, things same…the US remains in another echelon of valuations despite some convergence and reset in absolute terms. Rest of world—especially developed markets ex-US—are looking also a bit better vs recent history (and still at a steep discount vs US).

Earnings explain a large part of the gap here, but you might wonder how repeatable the big disruptive gains of tech of the past decade are going into the future…i.e., tech has eaten the world, perhaps needs to rest a while to digest what it just ate.

Chart Of Global PE10 Valuation Ratios

10. Global Equity Super Sectors: While Tech is just resting, commodity stocks and defensive sectors have charged out ahead. Indeed, this year one of the few assets that turned in solid positive returns was commodities and commodity stocks.

But also on the defensive side, those defensive sectors’ relative performance acted like a pretty decent diversifier/downside hedge…at a time when few things worked on that front.

Looking forward, it’s been a solid-short-sharp run here on this chart, and one can’t help but wonder if a period of consolidation or more choppy harder gains is now due.

Global Super Sector Relative Equity Performance Chart

11. Low Quality Credit – Low Risk Premium: Another area where we’ve also seen an initial reset is in credit risk premia—the spread of spreads composite for the lowest quality credits has spiked from previously extreme expensive/complacent levels. The worry here with this one is that with recession likely incoming, rather than revert to long-term average and just stay there or go back down…probably more likely to see overshooting.

Worst case would be a round of credit stress if borrowing costs surge further, profit margins get squeezed on both ends, and something a little unforeseen dog-piles on. We’re still in the middle of this thing, no time to be a hero on risk exposure just yet.

Credit Risk Premium, Low Quality Credit Spread Chart

12. China Property Downturn: Finally, the property downturn in China has only intensified as COVID lockdowns complicate and policy makers have still been relatively slow to turn the corner on stimulus settings.

Right now it is clear the main focus is on controlling COVID, but I reckon the next step will be a pivot to easing—especially as and when it becomes clear the rest of the world is in recession and as the property downturn looks set to linger for longer.

Perhaps a case of bad news is good news, but again though, we do actually need to see things turn the corner: it’s one thing to anticipate a change in policy—another thing for that change to actually come. Meanwhile the equities there are looking a little better.

Chart Of China Property Prices And Leading Indicator

Summary and Key Takeaways

• The Fed has pivoted aggressively and fully into catch-up mode as inflation expectations are at a fever pitch and risk anchoring higher; expect a likely further string of rate hikes and progression on balance sheet normalization (at least until growth risks elbow out inflation risks—and it’s going to need to be *obvious* to make the Fed pause let alone pivot).
• The global pivot from stimulus to stimulus removal and outright tightening poses risks to just about every asset class, as we have clearly already seen this year.
• In terms of the growth outlook, downside risks dominate over any upside risks, and virtually all signs point south for the global economy this year and into next.
• Geopolitics, COVID, and Fed catch-up have cemented the recession thesis.
• A key issue with regards to a growth slowdown and monetary tightening is the reality of multiple major asset classes still looking expensive despite an initial reset, but things have shifted here a lot. That said, property is likely the next shoe to drop given ever-loftier valuations.
• With many assets still richly priced in absolute terms, relative value remains the last bastion, and indeed rotation likely remains a key theme this year. But perhaps one pocket of emerging value is in bonds, both treasuries and global ex-US.
• All in all, a defensive skew and eye on risk management is the prudent path.

Overall: Headed into H2 it’s hard roads ahead as we’re clearly in the middle of a global equity bear market, and impending global recession. Valuation resets remain a work in progress, but there are clear emerging opportunities for active asset allocators.

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