Podcast Summary
Market Rally and Economic Uncertainty: Despite market optimism, economic landscape remains complex and uncertain. Inflation not solely driven by demand, but by disruptions. Maintain nuanced perspective.
Despite the recent market rally and optimistic sentiment about a potential soft landing, the economic landscape remains complex and uncertain. Principal Asset Management, with its global perspective and local insights, continues to navigate these challenges in real estate investment. In the financial markets, the shift in sentiment towards a potential soft landing and the possibility that inflation may not be as entrenched as feared, is a topic of debate. Victor Schutz, a global strategist at Macquarie Capital and a repeat guest on Odd Lots, has consistently held the view that much of the pandemic-related disruptions to the goods, services, and labor markets would eventually normalize. He argues that the current inflation is not primarily driven by aggregate demand but rather by these unprecedented disruptions. The market's quick shift to soft landing talk and the reemergence of the term "transitory" in the context of inflation, highlights the ongoing uncertainty and the importance of maintaining a nuanced perspective.
Economic disconnect between goods and services markets: Despite COVID-19 recovery, goods demand is lagging behind services. Inflation is elevated but not yet embedded, with disinflationary pressures and occasional inflationary spikes making it challenging to establish expectations. Central banks should adjust policies based on shifting demand patterns, not aggregate demand.
The current economic situation involves a disconnect between goods and services markets, with goods demand still recovering from the COVID-19 shock while services have mostly recovered. The speaker argues that inflation, which has been elevated, is not yet embedded in the economy, and therefore should come down. He also highlights the presence of both strong disinflationary pressures and occasional inflationary spikes, making it difficult to embed expectations. The speaker's perspective is that the issue is not one of aggregate demand, but rather a shift in demand patterns, and that central banks should adjust their policies accordingly. As a leading real estate manager, Principal Asset Management aims to provide local insights and global expertise to help clients navigate this complex economic landscape.
Deglobalization and Inflation: Despite labor's decreasing role in arbitrage, increasing unit labor costs, and disruptions from deglobalization and the shift towards services and technology, inflation is not expected to be endemic, as factors like reindustrialization in the US and gradual ESG evolution mitigate costs.
The ongoing trends of deglobalization and the shift towards services and technology are not expected to lead to endemic inflation, despite some concerns about rising costs and disruptions. According to the discussion, labor's decreasing role in arbitrage, increasing unit labor costs in emerging markets, and the flexibility of reindustrialization in the US are factors that mitigate the inflationary impact of these trends. Additionally, the ESG agenda is expected to evolve gradually, with a focus on cost reduction rather than just adding new costs, and technology advances continuing to reduce the cost of implementation. However, there may still be pockets of inflation in certain commodities, such as oil and coal, due to inefficient delivery and usage.
US Economy's Reindustrialization: Aiming to Outpace China: The US economy is reindustrializing to become more self-sufficient in manufacturing sectors like semiconductors and batteries, driven by a productive labor force and lower unit labor costs. Legislation like the CHIPS Act and Inflation Reduction Act support this effort, potentially putting China a few generations behind.
The US economy is undergoing a reindustrialization process, aiming to become more self-sufficient in manufacturing sectors like semiconductors and batteries. This shift started a decade ago and is driven by the recognition that the US needs to slow down China's progress in these areas. The US has a significant advantage due to its more productive labor force and lower unit labor costs. Legislation like the CHIPS Act and Inflation Reduction Act are part of this industrial policy spending plan, aiming to onshore manufacturing and reduce dependence on foreign sources. China, currently responsible for about 30% of global manufacturing, is still in the early stages of deindustrialization and heavily reliant on Western intellectual contributions. The US's reindustrialization could potentially put China a few generations behind. However, geopolitical tensions and the availability of resources like copper, nickel, cobalt, lithium, and rare earth elements could impact this process. Overall, the next few years could see lower geopolitical pressures, providing windows of opportunity for the US to make significant strides in its reindustrialization efforts.
US vs China: Tech Leadership and Economic Challenges: The US is focusing on tech leadership while China grapples with declining productivity and economic uncertainty. US intellectual contributions give it an edge in the race for future tech dominance.
The US aims to maintain and expand its technological and intellectual leadership over China, focusing on areas like batteries, rare earths, bio-attacks, and chips. China, on the other hand, is facing conventional deindustrialization and agricultural revolution, and may struggle to return to high growth rates beyond the COVID recovery due to declining labor and capital productivity. The Chinese government is stimulating the economy again, but it remains uncertain whether this will lead to inflation or deflation for the rest of the world. China's productivity has been declining for the last 10 years, and the only ways to reverse this trend are by shrinking the role of the state or implementing long-term reforms. The US, with its strong intellectual contributions, is well-positioned to widen the gap between itself and China in the coming years.
China's Economic Recovery and Global Markets: Uncertainty Ahead: China's focus on economic stability and growth brings uncertainty to global markets, with potential positive and negative factors balancing each other out, including geopolitical tensions and price action in commodities.
China's economic recovery and its impact on global markets are uncertain, with potential positive and negative factors balancing each other out in the short term. The ongoing geopolitical tensions, particularly between Russia and Ukraine, are expected to remain volatile but may not escalate to a full-blown conflict. China, which has been focused on reshaping society and geopolitics over the past decade, is now prioritizing economic stability and growth. However, it's unclear how consistently China can return to the high growth rates of the past, and this uncertainty could impact global markets. The price action in markets, such as the surge in copper prices and relatively stable oil prices, may offer some clues about the direction of the Chinese economy and global demand. Overall, the coming years are likely to bring a mix of geopolitical tensions and economic shifts, making it important for investors to stay informed and adapt to changing market conditions.
Geopolitical tensions to remain stable but prevent reconciliation: Geopolitical tensions will persist, leading to a stalemate, while central banks face inflation challenges and may change rhetoric for rate cuts by 2024, but earnings growth will be more constrained.
Geopolitical tensions, particularly in areas of geopolitical instability like the Taiwan Straits, Ukraine, Belarus, the Balkans, the Middle East, and the Himalayas, are likely to remain relatively stable in the next couple of years, despite potential inflation concerns and central bank policies. The speaker suggests that the drawing of clear lines between enemies and friends, as seen in the Abraham Accords, can lead to a stalemate, preventing chaos but also preventing reconciliation or trust. In the economic sphere, central banks are facing a challenge as they try to control inflation while markets anticipate recession or disinflation. Central banks will need to balance their mandates and may start changing their rhetoric in late 2022 or early 2023, leading to rate cuts and potentially quantitative easing again in 2024. Despite these economic changes, earnings per share growth is likely to be more constrained in the coming years due to slower global economic growth.
Investors should not expect significant equity declines despite low EPS: Investors may face lower risk-free rates and equity risk premiums, leading to stable equity values despite low EPS. Principal Asset Management can uncover opportunities in today's market. Financial conditions and inflation are complex, with transitory inflation and evolving central bank actions shaping the economy.
Despite a potential low EPS for companies in the current economic environment, investors should not expect a significant decline in equity values. This is due to the likelihood of lower risk-free rates and equity risk premiums, creating a "Goldilocks" scenario. As a leading real estate manager, Principal Asset Management is well-positioned to uncover opportunities in today's market for their clients. Regarding financial conditions and inflation, it's important to note that while most inflation may be transitory, financial conditions can still impact the economy. However, the relationship between financial conditions and inflation is not always straightforward, and the yield curve's predictive power for recessions may be overstated. Central banks' communication policies and the ability to react quickly to changing conditions make the inversion of the yield curve less significant than in the past. The current low short-term interest rates do not necessarily indicate that the Fed will be cutting soon. Instead, factors such as disinflation or a recession could trigger rate cuts. Ultimately, the persistence of the current yield curve shape may impact investment decisions and the economy, but its significance should be considered in the larger context of economic conditions and central bank actions.
Economic Shifts: Inflation and Monetary Policy: Central banks may cut rates faster than anticipated due to declining inflation, communication strategies play a crucial role, and market reversals can occur rapidly in our digitized economy
The economic landscape is expected to experience significant shifts in the coming years, particularly in relation to inflation and monetary policy. The speaker believes that inflation will decline faster than anticipated by central banks, leading to potential rate cuts to maintain economic growth. Central banks' communication strategies will play a crucial role in guiding monetary policy decisions. While there are some unique cases like China and Japan, most major central banks, including the Federal Reserve, ECB, Bank of Canada, and BOE, are expected to align in their approaches. The speaker argues that the abundance of capital and our digitized economy allow for rapid market reversals, and past events like the Fed's quick response to the 2018 market downturn demonstrate this flexibility. Despite the ongoing COVID-19 pandemic, the speaker believes that it has primarily accelerated existing trends rather than fundamentally changing the economic landscape.
Challenging assumptions about the economy and financial markets: The global economy may be returning to pre-COVID trends, defying the notion that cheap money is a thing of the past and that COVID marked a significant shift from disinflationary impulses. Geopolitical depressurization and the yield curve's diminished usefulness in the post-industrial age were also discussed.
That the global economy may be returning to pre-COVID times, with traditional supply countries generating deficits and requiring capital from the rest of the world. This idea challenges the notion that cheap money is a thing of the past and that COVID marked a significant trend break from the disinflationary impulses of globalization. Additionally, the conversation touched on the potential for geopolitical depressurization and the idea that the yield curve may not be as informative in the post-industrial age due to the numerous factors influencing bond yields. Overall, the speakers suggested that it may be beneficial to reconsider some prevailing assumptions about the economy and financial markets.
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