Macro: Sandcastle economics
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OP 2020: The sudden arrival of stagflation rewards value over growth
Steen Jakobsen
Chief Investment Officer
Summary: The iShares MSCCI World Value Factor ETF leaves the FANGS in the dust, outperforming them by 25%.
Nearly fifty years after the end of the nominally hard-money Bretton Woods system, central banks have reached the end of the road with interest rate policy. Having serially manipulated the market to soften the blow of every recession cycle and therefore preventing the clearing of the system, they have now entirely destroyed price discovery. And from here, the only tool left is outright money printing to stimulate the economy, an MMT-inspired shift in the next cycle that will spike inflation to the highest levels in a generation.
The world has now come full circle from the end of the Bretton Woods system, when it effectively shifted from a gold-based USD to a pure fiat USD system, with endless trillions of dollars borrowed into existence — not only in the US but all over the world. Each credit cycle has required ever lower rates and greater doses of stimulus to prevent a total seizure in the US and global financial system. The mispricing of money and bailing out of zombies has seen productivity growth crater as low rates encourage chasing asset values higher and malinvestment in unprofitable unicorns such as Uber and WeWork. They also allow zombie, debt-laden companies to survive.
With rates at their effective lower bound, and the US running enormous and growing deficits, the incoming US recession will require the Fed to super-size its balance sheet beyond imagination to finance massive new Trump fiscal outlays to bolster infrastructure in hopes of salvaging his election chances. But a strange thing happens: wages and prices rise sharply as the stimulus works its way through the economy, ironically due to the under-capacity in resources and skilled labour from prior lack of investment. Rising inflation and yields in turn spike the cost of capital, putting zombie companies out of business as weaker debtors scramble for funding. Globally, the USD suffers an intense devaluation as the market recognises that the Fed will only accelerate its balance sheet expansion while keeping its policy rate punitively low. US unemployment rises and growth stagnates, even as inflation spikes ever higher. The year 2020 ends with the highest misery index (unemployment plus inflation) since the 1980s.
As the market narrative switches to stagflation, value companies and their solid, right here, right now earnings and dividends are highly prized over the stumbling growth companies, where weak growth weighs and where crazy high multiples were always about the mispricing of capital. The MSCI value ETF leaves the FANGS in the dust.
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