The global financial markets are always eventful. And yet, these days they seem even more eventful than average.
Here are some key questions I am noodling on these days.
Who Wins From The War?
To be very clear, I’ve got strong views on the war that’s going on. The behavior of the Russian government and the general population seems to be going from really bad to much worse.
What makes me even more worried, however, is that there are far too many players out there who benefit from a prolonged conflict.
China is a clear beneficiary. Nothing like watching two of your biggest competitors duke it out while you can take the moral high ground and play both sides.
Notwithstanding my full support for the US (in fact, I think they should be doing much more to support Ukraine), it also stands to benefit from the conflict – both economically (defense, oil & gas exports, etc.) and politically.
Now that they pulled the trigger, even Russia is a beneficiary. With the economy in tatters, the only way for Putin and co to stay in power is by fomenting the “we are at war” mentality at home.
Finding yet another external enemy (US, NATO, a random gay parade) has proven to be a highly effective way to get Russians to go yet another year on buckwheat and potatoes.
The losers are clearly Ukraine (for obvious reasons) and Europe (refugees, economic disruption, war at its doorstep).
This is more than just a philosophical argument. Ultimately, we are talking about a significant disparity between economic growth rates, career prospects, and investment returns.
If you have the requisite flexibility, you may want to tailor your career and investment strategy appropriately.
Are The Peace And Globalization Dividends Gone?
For thirty years now, we’ve benefitted from the (perception of) long-term peace and ever-increasing globalization.
Why build another nuclear submarine if you can provide free childcare to millions of people instead?
And why source commodities and basic components domestically if they are available at a fraction of the price from emerging economies?
The recent events have proven us wrong. And while I am confident the world can sanction/wean itself off Russia’s oil and gas, I am concerned about what happens to global trade if China grows increasingly belligerent (see Taiwan).
We are already seeing an increased focus on in-sourcing, especially in strategic sectors like semiconductors.
Ultimately, bringing production back on domestic soil may have benefits like the revitalization of the middle class. But it will also incur a significant economic cost.
Where Is Inflation Going To Shake Out?
US inflation was approaching 10% just a few weeks ago – and that was BEFORE the impact of the war, the sanctions, and the incremental supply-side shortages.
Now, historical inflation and forward inflation are two different things. The aggressive rate signaling by the Fed is increasing the cost of borrowing now and should be putting some immediate damper on further price increases.
That being said, monetary policy is far from a precise weapon.
If the Fed undershoots, we could well end up with double-digit inflation at some point this year, which will quickly decimate mine and everyone else’s cash holdings.
What Are The REAL Market Returns?
The past 15 years or so have been pretty easy as far as tracking your equity portfolio performance.
Inflation was either non-existent or negligible. For people long US equities, you could pretty much take the annual S&P 500 return as a true measure of performance.
If the S&P 500 is still at 4,500 this time next year, you aren’t flat – you are actually 10% (or whatever the inflation rate happens to be) down.
And if the S&P is at 4,950 – you aren’t up. Nope – the market simply made you whole on your money.
For better or worse, we are living in a new reality, and many folks will require a paradigm shift to get used to it.
What Happens To My “Number”?
It is now abundantly clear that at least some of the stock market outperformance last year was driven by higher future inflation.
In other words, the stock market expected companies to raise their prices, which in turn would increase their earnings, even if just on a nominal basis.
Assuming a constant valuation multiple, stock prices (and indices) went up.
The FIRE community was happy to bank the gains. Hardly a day went by without yet another “record net worth” update in my Twitter feed.
And yet, I am still to see anyone meaningfully increasing their target retirement “number”.
If you were aiming for $5m last year, you now need $5.5m. And if you were going for $10m, you need a whole million more.
Sorry to rain on people’s parades, but it is a moving target – and it’s going in the wrong direction.
How High Will The Rates Go?
At the moment, I’m actually not that fussed about mortgage rates.
Sure, they’ve gone up dramatically in a very short period of time.
Still, we are not even at the levels seen back in October 2018, and I don’t recall any asset pricing tragedies back then.
On one hand, there are significant long-term deflationary forces at play. Technology is one. Globalization (if you believe it is here to stay) is another.
But if near-term inflation keeps galloping up and we cross the 5.5% – 6% barrier on the 15 year fixed rates, we could see some significant strain on the system.
After 10+ years of easy money, seeing rates go that high could place some significant stress on the mortgage borrowers (once the existing fixed-rate mortgages are up for renewal) as well as a host of other financial market participants.
What Happens To The Housing Market?
The “problem” with the housing market is that it’s unlike any other market out there.
Buying a house isn’t just a financial decision, it’s an emotional decision. No one buys $500k of bonds because they want to settle down, raise kids, and build a treehouse in the backyard.
And so, you just can’t expect housing prices to react to interest rate rises the same way that other financial assets might.
People want (and need) a place to live. Builders need to build houses (and they aren’t building enough right now). Folks might stretch to buy houses by cutting back in other areas.
The baby boomer generation, sitting on massive levels of home equity, might look to unlock some of it to help their kids get a toehold in the market.
Now, I hope that the house prices decline, or at least moderate. But due to the factors above, it’s not a given.
In theory, the commercial (i.e. multi-family / mixed-use) market should be more rational. No one buys an investment property because their biological clock is ticking.
But it’s also not that simple. If folks can’t buy a house, they need to rent. If rents keep going up, so do the property values.
We will likely have clarity on some of the questions above within the next few months, while others may take years and decades to play out in a definitive way.
In the meantime, the most important thing you can do is to continue investing through the cycle.
No one gets all of the questions right. But ultimately, we humans have been pretty damn good at prospering over time.
Stay disciplined, continue saving and investing, and you are bound to end up far ahead of where you have started.
As always, thank you for reading – and happy investing!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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