Good afternoon,
Nixing the near-Nixon narrative. With our US counterparts enjoying their July long weekend festivities, some of our usual weekly analysis is not available today, but there’s always something!
Comparing today’s political and financial environment to past iconic decades has been habitual of late. In the 30’s the pre-WW2 political divisions dominated the landscape when the depression wasn’t. In the late 60’s and 70’s, inflation, the protests at the ’68 Democratic convention and resignation of US President Johnson is compared to the Biden situation now.
Here’s a few thoughts from some of our analysts on why this is not that much like the 70’s:
Not that 70’s Show: Throughout the most recent inflationary episode that we have seen this cycle, there have been a number of comparisons between the geopolitically induced commodity shocks of the 1970s and the significant rise in energy prices following the onset of Russia’s invasion of Ukraine (2022). These comparisons have shaped expectations for monetary policy, market behaviour, and induced paradigm shifts in inflation expectations – something we believe is not warranted given the differences between cycles. The two inflationary episodes of the 1970’s are not resemblant of a maturing business/macro economic cycle and were driven by exogenous energy shocks. Despite some of the similarities, the differing nature of current macro backdrop and that of the past suggests that concerns surrounding the potential risk of a “round 2” of extreme inflation in the next few years might not be the fixture it was then.
Exhibit: Round 2 of inflation
Source: PAG FIS, Bloomberg
In revisiting these examples from the past we look to highlight that the most recent wave of inflation, while aided by rising commodity prices, was primarily driven by a combination of robust demand conditions and significant supply chain challenges brought on by the pandemic. Government transfer payments shored up household balance sheets across much of the developed world, ultimately propping up demand for goods and services – while logistical snags caused significant delays in the delivery of goods.
The first round of inflation was brought on by the Organization of Arab Petroleum Exporting Countries (OAPEC) retaliating against the United States and select allies for their support of Israel. The predecessor to present day OPEC+ restricted the export of oil to a these countries. For context, “the embargo ceased U.S. oil imports from participating OAPEC nations, and began a series of production cuts that altered the world price of oil. These cuts nearly quadrupled the price of oil from $2.90 a barrel before the embargo to $11.65 a barrel in January 1974.” But the weaponization of oil managed to drive clear risks to price stability throughout the entire global economy. While the embargo was eventually lifted in 1974, higher oil prices ended up sticking and increased investor/market sensitivity to geopolitical stress in the middle east.
The immediate response to managing inflationary pressures that were brought on by the oil embargo was a fast and aggressive monetary tightening campaign that brought the overnight rate from 5.5% to a peak of 13% in roughly 15 months (see below). This triggered a slowdown in the broader economy as demand conditions waned, bringing the CPI off its peak while remaining elevated.
A resurgence of geopolitical stress in the form of the 1979 Iranian revolution, that saw a regime change and alignment with the former USSR, drove another spike in oil prices and another rise in the CPI. The risk of this occurring again in the U.S. is not as high as it was in the 1970’s, in our view. This is for a number of reasons. While exogenous geopolitical events could drive oil (and subsequently gasoline) prices higher on the global market, the U.S. has become a net oil exporter and will likely see more stability as domestic refiners operate near full capacity. This is in contrast to previous episodes of the 1970s. On top of this, monetary policy seems to be leaning more restrictive, and the aggressive easing cycle that occurred in 1974-5 seems less likely to be as persistent.
Let’s hope
Trees Don’t Grow to the Sky: In case you missed this last week, this was in the midst of an admittedly busy email, this is worth a quick look. Global Insight Equity Perspective - Midyear 2024 (rbcinsight.com)
Friday Charts:
Do you have “bad breadth?” Equity market breadth tends to mean revert (see charts below): “History suggests weak breadth itself isn’t a precursor of market weakness: In years of mega-cap leadership since 1986, the market was up the subsequent year nearly 75% of the time."
China: Commodity supply insecurity (see chart below from J.P. Morgan): “To ensure the long-term security of strategic minerals, China has also placed priority on the build-up of its strategic stockpiles. Over the last two economic recessions, China’s authorities took the opportunity to construct vast storage facilities and fill them up with commodities at relatively depressed prices. Today, inclusive of exchange, visible commercial inventories, and strategic stockpiles, China holds an estimated 96% of global visible copper inventories, 52% of global visible aluminum, 67% of corn, 58% of milled rice, 51% of wheat, 33% of soybeans and 23% of crude oil. Chinese State Reserve Bureau (SRB) holdings alone are estimated to account for 83% of global copper inventories and 21% of global aluminum inventories.”
S&P 500: It’s been a while since a 2% down day (see chart below): “The S&P 500 hasn’t had a 2% daily decline for a very, very long time. In fact, the last time it fell 2% or more in one day was way back in February 2023. Although this could suggest we are long in the tooth for some volatility, the chart shows there have been some streaks that have actually lasted much longer.”
S&P 500: A difficult environment for diversified portfolios (see chart below): “The percentage of S&P 500 members beating the index is extraordinarily low. Slightly more than 25% of stocks have outperformed the S&P 500 year-to-date, putting it on pace for the lowest percentage since at least 1973.”
Shorter tech adoption cycles (see chart below): “Throughout history there has been a lag between the development of new technologies and their impact on productivity. This reflects the time taken to diffuse them through economies, and for infrastructure and processes to adapt so that firms can harness their productivity potential. These lags have shortened over time.”
AI hyperscalers capex (see chart below): “Investment spending by five of the major AI hyperscalers in the U.S.―Microsoft (Azure), Meta, Amazon (AWS), Oracle and Alphabet (Google Cloud)―has increased in recent years and is projected to rise meaningfully in 2024.”
U.S. household debt resilience (see chart below from the Wall Street Journal): “As of the first quarter, only 11% of outstanding household debt carried rates that fluctuated with benchmark interest rates. That metric has hovered around this historically low level for over a decade. But it only started to matter when the Fed began its campaign.”
Uranium (see chart below): “The underlying supply-demand fundamentals for uranium are far stronger than those during the 2000s bull market and might actually be the strongest ever. Turning to nuclear reactors under construction, the picture is also more bullish compared to the mid-2000s. By the end of 2005, only 18 nuclear reactors under construction were expected to hit the grid in the medium term, for a total gross capacity of 13 GWe. Today, we are talking about 53 such nuclear reactors expected to hit the grid by 2030, adding ~60 GWe.”
What FX reserve data tell us about foreign interest in Canada (see chart below from NBF): “The Canadian dollar is one of eight currencies included in the IMF’s COFER basket. At 2.57%, the Canadian dollar’s allocation ranks fifth on the list, behind USD, EUR, JPY and GBP. Official FX reserves are large enough that CAD’s ~2.6% share works out to $400 billion, representing a four-fold increase in CAD-equivalent official reserve interest since the end of 2012.”
Are old presidents new precedents? (see chart below from Statista): “Biden and Trump were the oldest U.S. presidents ever at the time of their inauguration. Trump was 70 years old in 2017 and Biden was 78 in 2021. Ronald Reagan, who was 69 in 1981, comes third. Taking a look at all presidents’ ages at the time of their inauguration since 1789, no clear trend is visible. Before Trump and Biden, presidents’ ages were actually well below average. Barack Obama took office at 47 years and 169 days, making him the fifth youngest president at the time of inauguration. Bill Clinton, who was 46 when he took over, was the third youngest―only John F. Kennedy (43) and Teddy Roosevelt (42) were younger.”
Enjoy your weekend!
Eat hotdogs. And as my cheeky American son-in-law recently joked when I wished him a Happy July 4th:
“It’s only a rebellion if you lose.”
Mark