I’ll explain why the bags will go on the swing
2022 started off as a bumpy year, with pitted road sections alternating with flowing sections. The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds
During the first phase of an economic recovery cycle after a recession, stock markets fly into the sky of fantasy. It is as if they are moving in an obstacle-free space, in which the laws of physics are suspended. After a recession, everyone is underweight, either because they sold or because the value of what they held fell as a percentage of the portfolio. The light positioning becomes the fuel of the rise, because everyone must normalize their weights and do not have the time to weigh the pros and cons of every single purchase choice with the slingbar. The market rises like whipped cream.
When the weights have returned to normal (and in some cases they have gone even further) the general laws of physics are restored and the sling bar becomes the main tool for investment choices, which become more rational.
Alongside the greater rationality of choices, the normalization of portfolios restores fear as a permanent component of decisions. As a result, each cycle of equity rally, after the first carefree phase, will invariably face four challenging tests in the course of its unfolding. There are four rites of passage that in the four ten-year cycles that have followed one another since the beginning of the 1980s have marked the passage of time for the recovery of the economy and the rise in shares.
These trials, regularly accompanied by waves of fear, are fear of rate hikes, fear of growth, fear of inflation and fear of profits. In normal cycles these waves of fear follow one another in the order we have said. The fear of a rate hike manifests itself between the second and third year of recovery. Between the fourth and fifth year, fear spreads that the rate hike has been excessive and could lead to the premature end of growth. In this phase, central banks stop the rate hikes and the economy has time to adjust to previous hikes and start growing again. When the re-acceleration becomes evident, the fear of inflation arrives which, until that moment remained under the radar of the markets, picks up speed and forces the central banks, now late on events, to return to raise rates. The latest fear, in the mature phase of the cycle, is that of a profit recession. The economy continues to grow, but corporate margins are being squeezed by the excess investment of previous years, the depletion of backward consumer demand, and the rise in labor and component costs.
The current expansionary cycle, which started in the second half of 2020, presents significant anomalies compared to the four previous major cycles. The main one is that it will likely be shorter, more focused and more intense. The second is that inflation, which in classical cycles occurs in the second half of the cycle, has already manifested itself this time in the second year. The third is that inflation did not initially lead to a wave of interest rate fear, because it has long been seen as transitory.
So far, we have had two waves of fear for rates in this cycle. One was in early 2021, before the price explosion, and it was not due to inflation but to the great strength of the economic recovery. The other has been in the past few weeks and has led to a flattening of the curve and a drastic downsizing of the unprofitable growth equity sectors.
Next year, ahead of previous cycles, we may have a wave of growth-related fear. We will in fact have higher rates, less liquidity and a slowing economy. The fear of a policy error will be greater if inflation has not fallen convincingly in the meantime. Perhaps next year we will also have a wave of fear for profits if the slowdown in final demand, also favored by monetary and fiscal normalization, will take away space for companies to offload the increases in upstream costs and in the cost of work.
All of this may sound worrying but it is, as we have seen, to a large extent physiological. The large equity rises of previous cycles have been studded with fears small and large and have had mid-cycle corrections at times violent (1987, 2018) and at other times significant (1997, 2015-16), then managing to recover well and make mark new highs in the final phase of the cycle. The important thing, even in this new cycle, will be to avoid getting hurt too much and exit the market during the waves of fear, trying to look at things from above. If 2021 was a year of effortless hikes, 2022 started off as a bumpy year, with pothole-filled road sections alternating with flowing sections. The result will be a wide but well-defined trading range (between 4000 and 5000 for the SP 500 index) and not particularly risky. In other words, it will be an environment with ample space to work constructively, aided by a widespread greater rationality and selectivity (see the behavior of great technology these days). For its part, 2023 looks like a riskier year that will need to be tackled with greater caution.
Coming to the short term, the good recovery that was taking shape after the wave of fear in January is cooling a bit due to some disappointments on earnings, the general (but temporary) slowdown of this first quarter and more central banks. reactive with respect to inflation. This cooling will have a positive side if he manages to break the neurotic cycle of corrections and quick counterattacks.
As for the substance of the concerns, it is encouraging that as many as five rate hikes for this year are already incorporated in government dollars, that the ECB, beyond the less relaxed tones, will maintain a very slow pace in monetary normalization and that the second quarter will again see strong growth in all economies.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-le-borse-andranno-sullaltalena/ on Sun, 06 Feb 2022 06:33:58 +0000.