Millennial Macro

After a year of very little volatility in 2017, the first half of 2018 has been far less easy to navigate.  With that in mind, the following seeks to outline the bull and bear case for the remainder of the year.  The points listed below represent signs that one would expect to see when the financial markets finally break one way or the other.  Bull Case: Long term treasury yields continue to climb signaling improving expected nominal growth (rising inflation and aggregate output). US equity markets end this period of consolidation following the Q1 intermediate price peak by making new all-time highs as investors price in improving future earnings.  This would confirm the ongoing strengthening in aggregate nominal growth. High yield credit spreads remain narrow which show little indication of distress in debt markets.  This again is consistent with a stable economic and financial backdrop. The USD weakens after eventually hitting resistance....

After the end of a volatile and tumultuous Q1 2018 for risk assets, this felt like an opportune time to recall the last risk-off period that started midway through 2014 and ended in Q1 2016.  The purpose of doing so is in large part to determine whether today's financial and economic backdrop is similar to that one.  Although the 2014-2016 volatility in US equities did not result in a major cyclical disruption, financial market price trends suggested that the US and global economy had come perilously close to a possible downturn. 1.)  Nominal GDP growth topped out in Q3 2014. In Q3 2014, nominal GDP (total domestic spending) growth hit a high of 5.2% before sliding to as low as 2.45% in Q2 2016. Unlike that two year period, nominal GDP is currently experiencing an upswing with the latest Q4 reading coming in at 4.49%.  In fact, aggregate domestic demand growth has reaccelerated after a temporary dip in Q2 2017. Importantly, during much of 2014-2015 the Fed ...

Last month's post,  Are the signals that usually precede cyclical downturns present today? , pointed out how the current financial environment is not (yet) reminiscent of prior cyclical economic tops that ushered in major corrections in risk assets.  Despite the ongoing correction/volatility in global equity and commodity markets, the yield curve is still positive and above the January 2018 lows, the 10-year treasury yield remains in an uptrend (a sign of improving growth and inflation expectations), high yield credit spreads are still very low and have yet to widen materially, longer term moving average trends in equities still remain favorable, aggregate economic data suggests that the current upswing in NGDP remains intact. With all that said, it is certainly possible that in hindsight the February risk-off move could eventually be understood as the beginning of a major economic and financial market correction rather than normal volatility in an ongoing uptrend....

The purpose of this post is to understand the conditions that led up to the two most recent major cyclical economic and financial market tops in order to determine whether or not they are present today.  However, what the following does not seek to do is provide a short-term macro market outlook.  Nor does it attempt to predict the trajectory of the ongoing recovery from the Global Recession.  The goal is to simply determine whether or not today's macro environment is similar to that of the prior two cyclical turning points. Most importantly, this analysis is not a substitute for sound risk management.

Depending on the state of the economy, tax cuts that further concentrate income and wealth by primarily benefiting the affluent could either promote or inhibit an increase in economic activity. To determine which path is most likely to transpire, one would need to understand the answers to the following three questions. 1.  Is desired investment greater than actual investment?  In other words, is a lack of funding specifically preventing the private sector on aggregate from boosting capital expenditure to their desired levels? 2.  Will tax cuts for the (super) wealthy be funded via higher taxes or spending cuts that predominately fall on the middle class and poor or will they be funded by greater treasury issuance? 3.  Will monetary policy seek to offset the effects of fiscal expansion?  How would financial markets react in response to the Fed?

The treasury yield curve continues to flatten as long-term yields lag the rise in short-term rates.  

Given the cryptocurrency mania, it felt necessary to express a few thoughts on the matter.  The following uses the article,  Will cryptocurrencies trash cash? 'Fedcoin' could do it , as means to explore the topic.