What’s the difference between a conspiracy theory and truth? These days, about 3 weeks.
Some of the things I love about investing are the semi-tribal traditions. For instance, each month we gather around the campfire and trade tales of how Volcker slew inflation with his bare hands and share stories of ex-housing, core services inflation – a metric that roughly equates to a society that lives in caves with access to modern medicine and services, but we hunt our own food and find our own energy (… 3 weeks away, I guess?).
Conspiracy theories and campfire tales aside, this is a post that will take a look at central banks’ policies and throw around a few ideas about how this might play out in the economy and markets more broadly. There’s also a company that I think is worth a look.
At present there are three hypotheses about the direction of the global economic landing: soft, hard, or recently, none. I suspect the aeronautical metaphor has been stretched too far – perhaps even killed. The fact no one seems to be considering a take-off scenario, let alone a hard, soft or no-take-off scenario is worthy of note. (Hey, if the metaphorical horse is dead, it won’t mind the flogging.) It’s worthy of note because almost no one is positioned for it – meaning that if said take-off occurs, it’s likely to be a huge event.
I’ll admit I’ve spent the last ~6 months more confused than a chameleon in a bag of Skittles. Economically speaking, we seem to be at the Roadrunner & Coyote moment: off the cliff, legs turning, gravity slowly taking hold. Inflation is high, due to supply-side issues, while central banks try to solve this problem using a demand-side solution. The equivalent of trying to solve shin splints by amputating the patient’s legs. Then again, I guess to someone with a hammer, every problem looks like… a struggling consumer you can beat to death with a hammer.
Yet market prices suggest a sanguine future. Why? I think there are a few reasons. First, unemployment remains low, even with the mass tech layoffs. Second, inflation seems to be cooling… if you subject the figures to enough Procrustean torture. Third, like anyone without an idea of what to do, we in the markets wait and see.
Let’s look at each in turn. The unemployment percentage in major developed markets remains low. Historically so:
Low unemployment means more consumers have more money. For now. The bar on unemployment is so low it’s practically a tripping hazard in hell. I’m not suggesting this is a bad thing, just that it’s so low it is unlikely to continue.
Secondly, inflation seems to be slowing – which is great news. However, this is off an extraordinarily high base. Wages certainly haven’t kept up, making life more expensive – and that’s at the average (half of wage earners are worse off than this). I think this is a classic example of Wall Street lifestyle diverging from Main Street reality. If you’re earning a lot of money on Wall Street, you don’t notice small changes in the price of food, services, and transport because they’re negligible when compared to your total salary. Perhaps your savings rate declines slightly, but that’s it. If you’re just scraping by, saving none of your wages, this starts to hit you. Hard. I think it’s highly likely a recession is on the way – and not one presently felt by the fund managers and analysts on Wall Street, or indeed priced into markets.
Thirdly, fund managers, traders and analysts aren’t stupid. They’re in fact incredibly smart. This isn’t a statement born of self-aggrandisement, but one of respect. The people on the other ends of my (and indeed your) trades aren’t dumb, they’re clever. That markets haven’t incorporated the earlier pessimism in my post reflects something that must make sense, even if it’s irrational. Perhaps everyone is as confused as the chameleon. Waiting for the next data point, assuming everyone knows more than they do – but in fact no one does. A game, within a trade, within a game. Perhaps I need to do an Inception/Tenet marathon again.
So what does all this mean? I believe a soft landing is highly unlikely. The only things cushioning us from having hit the deck harder than the final scenes of Top Gun: Maverick are household savings (left over from the pandemic) and the delayed rollover of variable rate debt. Here’s a chart of US savings.
The facts are simple: 70% of US (and most other developed economies’) GDP is consumer-related. That’s you and me buying stuff. A further 20% is corporate capex. If the consumer is hurting, the corporations need to increase capex by 3.5x to compensate. I hate to break it to you: but corporations aren’t doing that (with the notable exception of Intel – a story worth watching); we’re up the creek without a paddle... Or even a canoe for that matter. Corporations are mostly trimming capex. Because the money comes from somewhere, either from new capital (debt: increasingly expensive, or equity: career suicide) or existing cash (which investors would rather have for themselves).
Catastrophising continued, Jerome Powell, Fed Governor, seems to spend his days quoting Paul Volcker. This is worth noting: Paul Volcker did indeed slay inflation with his bare hands once. He then started rate cuts to the cheers of the economy. Unfortunately, he started too soon. Ever stopped a course of antibiotics once your symptoms disappeared only for them to reappear a few weeks later? That’s what happened.
In Volcker’s case, the consequences were more severe. He had to raise rates to a much higher extent the second time, delivering the death stroke to an economy already knocked down. Volcker, to his credit, cites this as one of his greatest regrets. Jerome Powell is acutely aware of this history and appears determined not to repeat it.
Where this ends? I hate to disappoint you, dear reader, but, as always, I don’t know. It’s hard (although not impossible) to see markets accelerate from here. Perhaps Vladimir Putin turns out to be, like many of his adversaries, allergic to tea-vectored Polonium-212 and the war in Ukraine ends. Perhaps not. Even if the 212 scenario (come on, New-Yorkers, you must have seen that pun by now) plays out, there’s a huge global copper shortage on the way in ~2.5 years which will drive inflation even higher (a topic for another post). Economic deceleration is, in my opinion, much more probable. So how to play this doom and gloom? To my mind, it’s reasonably simple: solid execution in sound businesses is always worth a look.
Pure Cycle Technologies (PCT US) is one such business. It’s a US-based company that recycles polypropylene to near-virgin quality. Polypropylene is in car bumpers, cling film, food packaging, and everything in-between. But it’s a single-use plastic. The EU banned such plastics on 1 July 2022. PCT makes polypropylene multi-use. Because PCT’s process doesn’t alter the chemical structure of polypropylene, it recycles it at a quarter of the cost of producing new polypropylene. Using a utility-patented technology. Same performance? Quarter of the cost? At the current price, it looks good to me. Maybe it looks good to you? Let me know your thoughts. I’m always keen to debate ideas.
For now, look at the macro, but play the specific.
And as always, good luck out there,
James