MARKET UPDATE FEATURING INFLATION RELOADED

Financial markets continue to be buoyant and participants who give risk alerts seem to become ever more silent. This is not surprising, given that

• With every new all-time high they look more stupid
• Disruptive tech like AI, blockchain and quantum computers offers a great narrative for justifying new highs
• Investable funds have to go somewhere and real assets have become less attractive with higher interest rates

But didn’t we have that before? This time it’s different? Let us quickly analyze some forces that drive markets and could be decisive in the near future.

Historically, years with presidential elections in the US have predominantly been good years for the stock markets. So, it is just a traditional pattern that we see here. But we all know that the stock market is sort of a leading indicator for the real economy: market highs now mean a good economy tomorrow, as the future gets discounted in today’s stock prices. So, the question is, if there is enough reason to expect a good economy next year - or the other way around.

The short answer is: inflation and money supply could spoil the party. Stock market highs are not only driven by disruptive technology today, but also by the expectation of more leeway for central banks to lower interest rates a little bit more. Unfortunately, government debt in the US is growing at such an impressive speed, that it is likely to outgrow World War II levels next year for the first time. Unlike in the Eurozone this could leave less room for rate cuts. Even if general price indices do not go up, investors will just ask for a higher yield when taking US government risk. Donald Trump seems to be leading in the polls of swing states as of now and his economic plan would push up US government debt massively. Higher rates in turn will kill many economic activities, protectionist action is always likely to be only a short-lived aid for domestic companies.

So, if inflation comes down in the US, it will reveal lower economic growth than figures currently suggest, while at the same time rising debt should force the FED to stay tight. If inflation does not come down, rates will not move South either, growth figures will look a little bit better, but consumer confidence will turn sour.

The strong gold price -due also to global central bank demand and in part to worries of this kind- may also reflect such an investor sentiment. The inflation outlook of the University of Michigan (measured as Mean, not Median) has almost doubled recently after being benign since the 1980ies. Looking back a year from now this may be quoted as a warning signal by people who always claim, they had seen it coming.

Besides, global money supply as measured in M2 is by far lagging MSCI growth, calling for a correction reversion-to-the mean style. Either the index comes down or money supply goes up or they both move. When looking at these three scenarios, two out of three are rather bad for financial markets and the other one is not very likely to happen.

To sum it all up: Signs of positive economic development in the US may be overdone, the interest rate outlook is likely to be less smooth than expected and as a break to usual patterns the post-election party may be canceled sooner than most people think. If with every trading day the number of worried investors decreases, so should your stock market exposure. It won’t be different – not even this time!