History Repeats Once More...?
The markets are currently in flux. Trapped between what history shows and what the current macroeconomic environment suggests. Reading between the lines, and understanding what factors will ultimately shift prevailing sentiment will become increasingly difficult to decipher. Regardless, I will attempt to examine what led us here, where we are now, and what is to come.
HISTORY...?
Many economic theorists posit that the current macroeconomic environment indicates that we are currently in a market that seemingly aligns with behaviors observed in 1929, 2000, and 2008. Therefore, our current market may be operating in some grey area that holds qualities of a combination of these historic economic crises. Although many believe that we can use historical charts to predict the exact movement of the current market, I do not believe this to be true. Although there may be some truth to this belief, the mechanism behind the euphoric rise of our current economic conditions are relatively unprecedented. The scale and magnitude of stimulus injected into financial entities, consumers, and creditors through direct stimulus, loan originations, and low-interest rates have no historical equivalent. In theory, we have no accurate true historical equivalent to current market mechansisms.
As individual investors at a retail level, the layman trader has no easy way of obtaining information that may offer insights into the true systemic risk of a financial system. The SEC EDGAR system does allow access to corporate financial statements, but these statements may not provide a full or clear picture during times of crisis https://www.sec.gov/edgar/search-and-access. Regardless of this, it is still what I use most often to analyze corporate balance sheets to determine current or impending threats to their debt, liquidity, and valuation. The unfortunate truth, however, is that we will most likely not know the severity or extent of any theoretical "rot" until it is already too late. So with this in mind, how does one navigate such a tumultuous economic landscape?
As individuals, we often look for patterns and cues that are often repeated. This is what makes history such a useful tool in the field of economics. The flow of money, greed, and fear of loss are constants throughout history that boast an unwavering track record. These are innate to human behavior and rarely change with time. When we examine the flow of money (Who has it, how much of it, and what is it being used for), we can see that there is currently a glut of supply. Between 2020-2022 somewhere between $5-7 trillion dollars of stimulus flooded the markets. Therefore, it is clear that there is plenty of currency circulating. Once financial stimulus of any kind is injected into a system, it is then important to "follow the string" to see where it leads. After the initial stimulus injection, it became clear that the money led to banks, and can be seen in the FRED Economic Data chart fred.stlouisfed.org/series/PSAVERT. While this suggests a marked increase in consumer savings, it can also be misleading, as the stimulus checks were most commonly distributed directly into savings or checking accounts and immediately bolstered the rate. Predictably, the rate immediately fell as consumers cashed out the stimulus to spend. This cycle is then repeated with a spike during the second stimulus injection, and a subsequent fall immediately after. So then, the flow of money so far looks like this: US Treasury->Consumer banks->Consumer spending.
Predictably, inflation immediately reared its head. Prices skyrocketed, as corporate metrics adjusted to this new prosperous system of "free cash". Student loan debt payments during this time were in deferment saving an additional ~393/month (Average student loan monthly payment thecollegeinvestor.com/33643/average-student-loan-monthly-payment/ for consumers to spend on other necessities or purchases, and interest rates remained at near 0%. Although this "Epipen" to the heart of the US economy may have saved consumers from immediately defaulting on credit, the side effects of such an intervention have no reliable historical references to note.
Now, as we approach the end of 2022, the global economy appears to finally be experiencing these inevitable side effects. The reservoir of liquidity provided to the US economy and global markets is constricting, and the well is running dry. Corporations have experienced the most ideal and prosperous economic scenario any Black-Scholes model could possibly iterate, and many CEOs are now likely grappling with the impossible question of, where do we go from here?. Global economies simply cannot afford another stimulus injection that matches the scale and volume seen in 2020, and with that comes the harrowing reality that the most prosperous period in generations is coming to an end. Future growth metrics will pale in comparison to those experienced during this time of euphoric intervention, and earnings can only inevitably diminish. Student loan repayments begin again at the beginning of 2023, sucking any last drop of excess capital consumers had left. This, I believe, may lead to a critical turning point where the reality of the end of prosperity is fully realized.
Ultimately, if this thesis plays out, we may experience a period of rapid deflation where companies are forced to either lower prices or find other methods of keeping pace with plummeting consumer spending. Credit will constrict, Credit card defaults will skyrocket, and the US Treasury must suppress treasury yields via treasury buybacks, consumer incentives for holding US debt, or imposing significant taxes on real estate investing. All of this will happen exponentially quickly. Global events and crises will make it difficult for any officials to remain vigilant in any single aspect of the market to prevent a systematic collapse. This degradation in the division of attention among lawmakers in charge of keeping our systems functioning as intended will create the perfect medium by which any previously "undetected" economic instability can proliferate and reach critical mass.
SUMMARY
We are reaching a final "breaking point" in the US economy. The current system built to withstand financial turmoil has never been tested in an environment that has experienced such levels of financial stimulus paired with macroeconomic instability. This will result in a new "mutation" of financial instability that will prove to be significantly difficult to counteract. If a systematic collapse occurs when the government entities typically poised to intervene are experiencing significant turmoil themselves, they must find new ways of stemming the fallout. Although the mechanism by which the US Treasury funds itself creates a type of "perpetual loan" through its treasury issuances and yield payments, illiquidity in the treasury market may force emergency action to save itself. History doesn't necessarily repeat itself, but it often rhymes. And right now, history is about to become the greatest lyricist the world has ever seen.
HISTORY...?
Many economic theorists posit that the current macroeconomic environment indicates that we are currently in a market that seemingly aligns with behaviors observed in 1929, 2000, and 2008. Therefore, our current market may be operating in some grey area that holds qualities of a combination of these historic economic crises. Although many believe that we can use historical charts to predict the exact movement of the current market, I do not believe this to be true. Although there may be some truth to this belief, the mechanism behind the euphoric rise of our current economic conditions are relatively unprecedented. The scale and magnitude of stimulus injected into financial entities, consumers, and creditors through direct stimulus, loan originations, and low-interest rates have no historical equivalent. In theory, we have no accurate true historical equivalent to current market mechansisms.
As individual investors at a retail level, the layman trader has no easy way of obtaining information that may offer insights into the true systemic risk of a financial system. The SEC EDGAR system does allow access to corporate financial statements, but these statements may not provide a full or clear picture during times of crisis https://www.sec.gov/edgar/search-and-access. Regardless of this, it is still what I use most often to analyze corporate balance sheets to determine current or impending threats to their debt, liquidity, and valuation. The unfortunate truth, however, is that we will most likely not know the severity or extent of any theoretical "rot" until it is already too late. So with this in mind, how does one navigate such a tumultuous economic landscape?
As individuals, we often look for patterns and cues that are often repeated. This is what makes history such a useful tool in the field of economics. The flow of money, greed, and fear of loss are constants throughout history that boast an unwavering track record. These are innate to human behavior and rarely change with time. When we examine the flow of money (Who has it, how much of it, and what is it being used for), we can see that there is currently a glut of supply. Between 2020-2022 somewhere between $5-7 trillion dollars of stimulus flooded the markets. Therefore, it is clear that there is plenty of currency circulating. Once financial stimulus of any kind is injected into a system, it is then important to "follow the string" to see where it leads. After the initial stimulus injection, it became clear that the money led to banks, and can be seen in the FRED Economic Data chart fred.stlouisfed.org/series/PSAVERT. While this suggests a marked increase in consumer savings, it can also be misleading, as the stimulus checks were most commonly distributed directly into savings or checking accounts and immediately bolstered the rate. Predictably, the rate immediately fell as consumers cashed out the stimulus to spend. This cycle is then repeated with a spike during the second stimulus injection, and a subsequent fall immediately after. So then, the flow of money so far looks like this: US Treasury->Consumer banks->Consumer spending.
Predictably, inflation immediately reared its head. Prices skyrocketed, as corporate metrics adjusted to this new prosperous system of "free cash". Student loan debt payments during this time were in deferment saving an additional ~393/month (Average student loan monthly payment thecollegeinvestor.com/33643/average-student-loan-monthly-payment/ for consumers to spend on other necessities or purchases, and interest rates remained at near 0%. Although this "Epipen" to the heart of the US economy may have saved consumers from immediately defaulting on credit, the side effects of such an intervention have no reliable historical references to note.
Now, as we approach the end of 2022, the global economy appears to finally be experiencing these inevitable side effects. The reservoir of liquidity provided to the US economy and global markets is constricting, and the well is running dry. Corporations have experienced the most ideal and prosperous economic scenario any Black-Scholes model could possibly iterate, and many CEOs are now likely grappling with the impossible question of, where do we go from here?. Global economies simply cannot afford another stimulus injection that matches the scale and volume seen in 2020, and with that comes the harrowing reality that the most prosperous period in generations is coming to an end. Future growth metrics will pale in comparison to those experienced during this time of euphoric intervention, and earnings can only inevitably diminish. Student loan repayments begin again at the beginning of 2023, sucking any last drop of excess capital consumers had left. This, I believe, may lead to a critical turning point where the reality of the end of prosperity is fully realized.
Ultimately, if this thesis plays out, we may experience a period of rapid deflation where companies are forced to either lower prices or find other methods of keeping pace with plummeting consumer spending. Credit will constrict, Credit card defaults will skyrocket, and the US Treasury must suppress treasury yields via treasury buybacks, consumer incentives for holding US debt, or imposing significant taxes on real estate investing. All of this will happen exponentially quickly. Global events and crises will make it difficult for any officials to remain vigilant in any single aspect of the market to prevent a systematic collapse. This degradation in the division of attention among lawmakers in charge of keeping our systems functioning as intended will create the perfect medium by which any previously "undetected" economic instability can proliferate and reach critical mass.
SUMMARY
We are reaching a final "breaking point" in the US economy. The current system built to withstand financial turmoil has never been tested in an environment that has experienced such levels of financial stimulus paired with macroeconomic instability. This will result in a new "mutation" of financial instability that will prove to be significantly difficult to counteract. If a systematic collapse occurs when the government entities typically poised to intervene are experiencing significant turmoil themselves, they must find new ways of stemming the fallout. Although the mechanism by which the US Treasury funds itself creates a type of "perpetual loan" through its treasury issuances and yield payments, illiquidity in the treasury market may force emergency action to save itself. History doesn't necessarily repeat itself, but it often rhymes. And right now, history is about to become the greatest lyricist the world has ever seen.
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