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Investors are facing many reversals of trends that have been prevalent in markets for decades. Globalization that had a calming effect on markets is turning into reshoring and nearshoring. Fiscal policies that are supposed to suppress inflation are probably going to encourage more of it. Stephen Miran writes at Barron’s:
Despite the market fireworks, the most important speech at last month’s Jackson Hole conference wasn’t given by Federal Reserve Chairman Jerome Powell. It was delivered by Agustin Carstens, head of the Bank for International Settlements and former governor of the Bank of Mexico. Carstens is a significant global policy maker, but it was his message that mattered most. Recent economic volatility is not a fluke, he argued. Changing global megatrends will reshape the entirety of the global economy, forcing a serious rethink of economic policy.
These forces have significant implications for asset markets, and investors should take notice.
From the early 1990s to the late 2010s, confluent megatrends drove low volatility in growth, inflation, and asset markets. Carstens emphasized globalization, geopolitics, and demographics, but the economic mix was significantly broader than that. Monetary-policy makers intervened with interest-rate cuts and quantitative easing whenever there were hiccups in the stock market. Fiscal policy makers provided bailouts to banks in 2009, and broader support to households and small businesses in 2020.
Corporations, recognizing the presence of a policy “put” beneath economic growth and markets, took more risks. Retailers and wholesalers developed just-in-time supply chains, manufacturers exploited cheaper labor abroad, and financial institutions took leverage that would make a loan shark blush. Antitrust and industrial policy went dormant.
Carstens’ speech gave voice to what has been apparent for some time: Not only have the volatility suppressants stalled, but they are also reversing. Fiscal and monetary policy are now driving volatility higher. Lest you think policy makers have found religion on inflation, consider that the Biden administration is still pushing in the wrong direction. New student-loan forgiveness will make a hole in the federal balance sheet multiples of the total deficit reduction provided by the Inflation Reduction Act. The IRA itself will further distort the supply side at a time of grave supply-demand imbalance.
Antitrust policy has been resurrected, as Congress and the Department of Justice rethink the role of Big Tech in our economy and society. Geopolitics is back, with a vengeance. Risks from China, Russia, and elsewhere have underlined that companies cannot rely on stable trade relationships for either customer demand or supplier inputs. Not only might a business find its operations disrupted by a sudden and absolute Covid lockdown, but it could also find trade with its customers or suppliers suddenly illegal due to sanctions. The lesson for both governments and businesses is an increased emphasis on resilience. You cannot allow your supply chain to be at the mercy of Chinese politics, land wars in Europe, or natural disasters.
Companies are responding to the geopolitical sea change by moving from just-in-time to just-in-case supply chains, reshoring production. Washington is responding by reviving trade policy, and now industrial policy aimed at moving critical technologies and resource production back stateside, as in the recent bipartisan Chips Act aimed at semiconductors. However, the rollback of globalization is inflationary and will contribute to the Federal Reserve’s dilemma. Solving one problem exacerbates another.
There are two significant implications for investors. First, companies with the most secure supply chains and customer bases are less exposed to recurrent shocks originating abroad, and face fewer necessary capital expenditures to secure themselves. That means that companies with a strong focus on U.S. jobs, security, and growth should be expected to outperform in this dangerous new world.
Second, volatility will probably remain persistently high. The Fed’s independence lets it move fast, but it can’t fix many of the nation’s economic problems. Those require supply-side solutions legislated through Congress, which is slow. Once enacted, supply-side policies can take years to work their way through the economy.
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