One Step Closer
Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy, it's inherent virtue is the equal sharing of misery – Winston Churchill
On Feb. 26, 1848, Karl Marx and Friedrich Engels published the "Communist Manifesto," a seminal text in the history of political thought. However, it took a long time for the Manifesto to gain widespread attention in certain intellectual circles. It was more the upheaval of socialist parties across Europe following Marx's death that led to the popularity of Marx's and Engels's ideas.
At its core, the Manifesto presents a scathing critique of capitalism, arguing that the history of all societies is characterized by the class struggle between the bourgeoisie, or capitalists who own the means of production, and the proletariat, the working class, who sell their labor for wages.
Marx and Engels depict capitalism as a system rife with contradictions and injustices. They assert that capitalism inherently leads to the concentration of wealth and power in the hands of the bourgeoisie while the proletariat is subjected to exploitation and alienation. According to Marx and Engels, capitalism's relentless pursuit of profit results in the commodification of labor, where workers are treated as mere inputs to production, leading to a sense of estrangement from their work and themselves.
Central to the Manifesto is the idea that capitalism's internal contradictions will ultimately lead to its downfall. Marx and Engels argue that the capitalist mode of production creates the conditions for its destruction by engendering class consciousness among the proletariat and exacerbating economic crises. They envision a revolutionary overthrow of the bourgeoisie by the proletariat, leading to a classless society based on common ownership of the means of production.
The Communist Manifesto outlines several key demands and goals of the communist movement, including the abolition of private property, a progressive income tax, and free public education. Marx and Engels advocate for the centralization of means of production in the hands of the state and the establishment of a dictatorship of the proletariat to facilitate the transition to communism.
Now, about a hundred years after the first successful "revolution of the proletariat" in Russia, the track record of socialist revolutions is devastating. Neither in Russia nor in China, North Korea, Cuba, or Vietnam, communism led to the desired effects and resulted in the deaths of many who were not in line with the political visions of the rulers.
Up to this day, social liberties in the socialist countries that still exist are heavily suppressed. The most economically successful countries, China and Vietnam, survived because they decided to open up economically. The hope of many Western policymakers that economic opening would lead to social freedoms as well was prevented by the ruling party, as they used modern technologies and implemented surveillance measures.
The simple truth is that the attempted implementation of socialism or communism never yielded the results Marx and Engels had in mind. On the contrary, the hope that the proletarian revolution would lead to freedom for all always led to more suppression and misery.
And while everyone hoped that China would gain social freedoms when they entered the World Trade Organization, it seems more like the Western world is implementing more and more policies from China for "security" reasons. Economically, the share of socialist economic policy has also increased as policymakers try to guide the economy via regulation and subsidies.
With policies like the Green Deal and the Inflation Reduction Act, Western economies have increasingly drifted towards "central guiding," which has also heavily affected financial markets.
After many hoped for interest rate cuts sooner rather than later at the beginning of the year, the latest strong economic data has brought some resignation. The most significant impact has been felt in the bond and rates markets, where long-term interest rates have significantly bounced off their lows from late December 2023.
As a result of dialed-back rate-cut expectations, the US 10y Treasury yield is now back above 4%, German 10y Bunds are well above 2%, and UK 10y gilts are back above 4% as well. However, as suspected, the stock market's strength continued, and all major indices were near all-time highs.
Investors have wholly shaken off worries about the rise in interest rates as the economy continues to appear capable of handling them better than many, including myself, expected. At this moment, it seems any outcome can be interpreted as bullish for equities.
If economic data starts to disappoint, sentiment in financial markets will shift towards rate cuts, which should benefit stocks as long as there's no actual cutting. If the economy continues to support, it could be interpreted as signs of a broad-based recovery and that the economy has no problem coping with high rates.
Nevertheless, it should be noted that what could drive the major indices might not necessarily be good for small and medium businesses. Readers will know that small-cap stocks have moved sideways for quite a while now and that trend has not changed so far this year.
While the S&P 500 has gained about 30% since mid-2022, the most significant part of the gain is from the Magnificent 7 stock gains, which rose by about 60% during that period. The S&P 500, excluding the Magnificent 7, has only increased by 23%, slightly more than the Russell 2000, which increased by 17%.
For small caps, the outlook depends on whether the current expectations of an environment of "higher for longer" interest rates remain or disappointing economic data shifts sentiment toward more rate cuts. In the first scenario, small caps will likely continue trending sideways, possibly lower. At the same time, a shift in expectations towards more or sooner rate cuts could turn out to be beneficial for them.
Especially NVIDIA has had a remarkable performance for months; thus, their earnings report this week was highly anticipated. Again, the company reported extraordinary earnings, with every metric beating expectations. That suggests that the stock's bull run is still not over, although many express concern about a potential bubble. However, to roughly quote George Soros, it seems we're currently at the stage where traders "put fuel to the fire."
As a result, the stock market's breadth has continued to worsen, which will likely continue. I wouldn't be surprised if the relative performance of the S&P 500 to the equal-weighted index will stretch farther to levels similar to the peak of the dot-com bubble.
While stocks have had a good year so far, the bond market remains under pressure as traders and investors dial back on their rate-cut expectations. German 10y Bund Futures are down nearly 5%, 30y Buxls are down about 10%, and 10y Treasury futures are down 2.85%.
While I suspected that bonds could eventually make another leg down, I am starting to question my neutral to bullish view in the short term. At the moment, it seems as if nothing could lift bonds in the short term. Central bankers' statements suggest they fear cutting interest rates too soon more than cutting them too late.
"Higher for longer" is the dominant narrative at the moment. Although this motivates the contrarian in me to assume the downward trend in bonds might end soon, I fear that I have started to become emotionally invested in that view. Thus, I changed my short-term view on long-term bonds to neutral.
The chart picture for 10y Bunds Futures also suggests a bearish continuation of the current downward trend, and a drop back to the 130 area doesn't look far-fetched. The 10y Bund yield currently is 2.46%, up 46 basis points year-to-date. A drop into the 108 area could be expected for US Treasury futures.
As long as consumption remains strong in the US, this could benefit the European economy and lead to further pressure on bonds. However, the picture for the eurozone remains mixed, as Thursday's Flash PMIs for France, Germany, and the Eurozone show.
PMIs in France surprised with a big beat of expectations, with a services PMI of 48 (45.6 exp.) and a manufacturing PMI of 46.8 (43.5 exp.). According to the composite PMI report (47.7 vs. exp. 45), despite continuing the economic contraction, the pace of the slowdown has cooled rapidly. Simultaneously, the report also mentions a further slowdown of cost pressures.
However, as rosy as the picture could be interpreted for France, the prospects for the German economy remain dire. Although Germany's services PMI slightly beat expectations by 0.2 points and came in at 48.2, its manufacturing PMI posted another heavy miss, with 42.3 compared to the median estimate of 46. The rise in the services PMI thus couldn't offset the miss in manufacturing, resulting in a composite PMI number of 46.1, which was well below the expected number of 47.5.
The Composite PMI posted its 8th consecutive month in contraction, but, as HCOB economist Tariq Kamal Chaudhry notes in the report:
After a glimmer of hope in recent months, the German industry is feeling pretty bleak now. The HCOB Flash PMI for Germany paints a gloomy picture in February. Clearly evident in HCOB’s PMI is a decline in output, alongside plummeting new orders both domestically and internationally. While falling manufacturing input prices and shorter delivery times may seem positive at first glance, especially given the pressure on prices and the crisis in the Red Sea, these factors actually underscore the chronic weakness in demand in the sector.
However, the picture also improved slightly for the eurozone as a whole. One could note a slight improvement in the overall situation with a composite PMI of 48.9, beating expectations by 0.5 points. Noteworthy, similar to Germany, it's the services sector that gives a glimpse of hope. While manufacturing output continued to decline in Germany and France, the rest of the eurozone recorded output growth. Overall, however, businesses reflect continuing pessimism.
Regarding the development of input and selling prices, the report shows increasing price pressures that HCOB economist Norman Liebke interprets as worrying for the ECB:
The latest HCOB PMI figures are likely to disappoint the ECB. Output prices have increased at a faster pace for the fourth month in a row. This is entirely due to the labour-intensive services sector, which continues to struggle with rising wages.
PMI numbers for the UK showed a more-than-expected expansion in services and manufacturing. As of writing, PMIs for the US are not published, although I expect that the numbers could potentially beat expectations, given the latest compelling economic data coming out of the US. (it turned out services were below, manufacturing above expectations)
The picture for the dollar remains rosy compared to other fiat currencies, while the exchange rate against gold has remained stable above 2,000 US dollars since December. Since October, the price development has decoupled from gold miners, with the GDX ETF currently trading at its October low of 26. If the price of 26 holds and gold continues its current strength, gold miners may offer a potential opportunity to close the gap.
The commodity space remains weak. Energy prices lately rose while natural gas prices dropped sharply by about 30%. On the other hand, agricultural prices show great fluctuations, with corn actually down about 13% and cotton up almost 15%. Overall, the Bloomberg commodity index is down to levels where it hasn't been since the end of 2021.
Overall, over the long term, commodity prices look attractive, although a potential economic downturn and slowing demand could serve as a catalyst to drive prices lower. Hence, it's probably too early to bet on a new commodity bull market that will undoubtedly return in the next few years, in my opinion.
The crucial point in the future will be the incoming economic data and how central banks react to it with their current "data-dependent" approach. Further, it's not far-fetched to expect a divergence in these actions, as the economy in the eurozone looks much weaker than in the US or the UK.
If one considers that the current picture shows fragile domestic economic demand in Europe as the main factor of weak production, I continue to suspect that it won't be the Fed that makes the first move this time. I think it will be the ECB, followed by the Bank of England.
Especially in Europe, inflation pressures might look grim, as expressed in the PMIs, in the short run, but in the mid-term, the money supply and weak demand should be a headwind for inflation. Arguably, the last remaining tailwind for the world economy is better-than-anticipated demand from the US, where the economy hardly shows a sign of stress. That's why the notion that equity valuations in Europe compared to the US are at shallow levels shouldn't be seen as an argument to favor European equities over their US counterparts. The music plays in the US, not Europe, and the extensive Keynesian subsidy programs in the US could potentially extend that situation.
Although US consumer price inflation looked hot in January, there are potential signs that it could have been a report that exaggerated the strength of price pressures. However, one won't know that until the next one or two CPI releases. While some still fear a potential wage-price spiral because wages are growing fast, the job platform Indeed recently published a wage growth tracker showing further deceleration.
Further, other factors indicate that a slowdown or even a fall in consumer demand could be on the horizon. First, as analyst Michael Shedlock recently wrote, buy-now-pay-later usage continues to increase among the financially fragile. Shedlock suspects that the usage could be more widespread among renters, who currently suffer from still-high shelter inflation, driving up the usage of buy-now-pay-later and credit cards, which could, at worst, end in a significant rise in delinquencies among renters.
If renters can't pay their rent anymore, this would result in a drop in income for landlords and hence lead to a fall in demand, not only among the financially vulnerable but also among wealthier people, who are the main drivers of demand.
Second, IRS data indicates that tax refunds for Americans could plunge significantly compared to last year. However, IRS experts stated one should remain cautious because tax season has just begun, and one needs further data to see whether the current drop in tax refunds is more broad-based. If it is, lower refunds would result in less money for consumption, which would lower demand.
Although things still look good on average, these numbers may show a too-rosy picture of the economy. The more the year advances, the more we will see whether that's the case. However, if one expects this to lead to a quick Fed pivot, it will likely be a mistake.
Jerome Powell has been underestimated since he announced the retirement of the word 'transitory'’ Since then, we have witnessed a continuing shift of metrics he used to support his tight monetary policy stance. His current most favored metric, core services ex. shelter, is one that is high by design. Powell will hide behind this metric for as long as he can to avoid cutting interest rates and to continue QE.
The Fed has put all sorts of mechanisms into place to keep systemic risks low and to avoid financial stress. As long as things aren't falling apart, one cannot expect Powell to stop being Volcker and turn into Greenspan again. And even then, one should remember that the Fed could come up with some program that will keep things afloat while it continues to shrink its balance sheet.
As soon as this day comes, and I continue to expect it will, the stock market will face strong headwinds. For now, however, the situation continues to remain beneficial for stocks, bad for long-term bonds, and somewhat neutral for commodities. But step by step, we're getting one step closer to the edge, and governments to become even more interventionist.
Everything you say to me,
Takes me one step closer to the edge (and I'm about to break)
I need a little room to breathe,
'Cause I'm one step closer to the edge (and I'm about to break)Linkin Park – One Step Closer
Have a great weekend!
Fabian Wintersberger
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(Please note that all posts reflect my personal opinions and do not represent the views of any individuals, institutions, or organizations I may or may not be professionally or personally affiliated with. They do not constitute investment advice, and my perspective may change in response to evolving facts.)
The remarkable thing about the current macro situation is that there are so many potential signs of impending trouble yet they are routinely ignored by investors across asset classes. if we have learned nothing else it is that macro events take a very long time to play out. have a good weekend