A slight moderation in inflation statistics, and a rising belief that growth is more durable than expected, has lulled markets into a false sense of security, according to senior portfolio strategist Phil Dobrin at American investment management firm Bridgewater Associates.
Markets are now changing their prices and discounting a future that is at odds with history and very different to Bridgewater’s own projections, Dobrin said, speaking at Conexus Financial’s Fiduciary Investors Symposium in Singapore.
“Markets are expecting Goldilocks, that’s fully discounted,” Dobrin said. “We don’t expect a market crisis like Lehman, but we do expect a lengthy recession that’s hard to pull ourselves out of.”
Markets are in the midst of an earnings bubble, and there is a disconnect between the earnings seen in listed companies and the health of the broader economy, Dobrin said.
Markets are also signalling there will be several more monetary tightening rounds then a full “candy cane” turnaround as inflation falls, with rates back towards a regular cycle at the end of 2024, Dobrin said. Earnings growth is expected to do a brief pause before descending to new heights.
This is unlikely, he said. “There might be a world where inflation is around the two-and-a-half percent target that central bankers have for it, but that world seems very incompatible with a world where earnings are going to resume their upward climb.”
The monetary tightening cycle of 2022 was far in excess of anything markets expected, he said. But while the first order effects of that tightening had been priced in somewhat, markets had not priced in the second-order effects such as the ongoing impacts on cash flows and assets.
Pricing had become “pretty extreme” after a “relief rally” on the back of slight improvements off terrible levels of inflation.
“Some people talk about a soft landing, I think if you look at the markets today I would say what’s discounted is more of a perfect landing,” Dobrin said.
It would be extremely unusual to see a monetary policy U-turn that was not followed by a recession, he said. More easing is discounted today than in 2020 at the onset of the pandemic, or in 2008 during the global financial crisis, he said.
Bridgewater is skeptical of some views that China’s re-opening will help markets achieve a soft landing. It is more likely to fan the flames of global inflation than global growth, as it will increase global consumption without increasing production, he said.
Margins are contracting and profits are likely to start declining in the near future as the effects of pandemic stimulus wash through the system, he said.
Dobrin said deflationary growth is not much to worry about, as there is “tremendous room” for policymakers to stimulate with quantitative easing and marry this with fiscal policy. But there is much more risk when inflation is high and at odds with the ability to stimulate.
“That’s very much where we are,” Dobrin said. “When central banks are constrained, assets can fall, and they can actually stay down without central banks being able to rush in and ease.”