Focus on major economic movements and their impact on the choice between technology stocks, commodity stocks and real assets

There are many moving parts to keep track of in the economy and financial markets. I was about to write "now", but of course there is always so much going on. There are always so many variables and unexpected events. However, it can sometimes seem like there's a lot going on, depending on what you focus on. For example, there are always military conflicts in the world, but not always in Europe, and not always involving a major nuclear power. Of course, for those living in Ukraine or enrolled in the Russian army, life has made a hugely significant U-turn.

However, most investors in financial instruments have long since become accustomed to the war. For example, the price of key commodities that spiked in the wake of Russia's attack has come down to the same or lower levels than before the war. This is particularly noteworthy in the case of electrification materials and oil and gas, given that there is still a clear energy shortage in the world and it will get worse over time unless the West in particular gets lucky with the weather. If the summer gets  too hot or the winter too cold, there will predictably be competition for fossil fuels again. Then both oil and gas could rise back to their pre-war peaks.

I mentioned that there is a lot going on (now). What I was mainly referring to is that there are contradictory signals in almost all areas. For example, there is an actual oil shortage, so much that the US is methodically depleting its Strategic Petroleum Reserve (SPR) week after week this spring and summer. At the same time, Saudi Arabia recently lowered its production plan, probably to slow the fall in oil prices - both WTI and Brent have almost halved since the peak of the war. It's a signal that perhaps the world's most well-informed oil nation sees weaker demand ahead. This leads us to the next moving part, China.

For it is China's economy that appears to be much weaker than expected this year, the year that was supposed to be the big reopening year after the pandemic. But instead of acting as a catalyst for a world that has been idling in anticipation of a trigger, China has instead slowed down further after a small, barely perceptible growth impulse early this spring. China's export and import figures are extremely weak, which is particularly noticeable in countries around Asia, especially South Korea. In China, as in the rest of the world, the slowdown is clearly manifested in low producer prices. Manufacturers are simply selling off their products as best they can when buyers are not so eager.

China's weakness is also reflected in the country's currency, the renminbi, which, after a positive move when it was hoped that it would reopen, is now very weak against the US dollar. According to several analysts, this is a sign of underlying problems in the US and European banking sector leading to dollar shortages throughout the world, including China. When interest rates were raised by 5% points in the US, Silicon Valley Bank and a few others collapsed. But, of course, the problems of those who survived are not over. Like mallards against the current, they are paddling at full speed to survive costly changes in interest rate spreads, but above the surface nothing is visible. The entire banking sector is affected, leading to a hunt for collateral (USD government securities) and reduced lending (which slows down the economy). You simply do not raise interest rates by 500 basis points with impunity, especially when the world has calibrated lending volumes for zero interest rates and after a historically traumatic start-stop maneuver due to a pandemic.

Macro analysis is never simple or obvious. One can identify some likely key variables to keep track of but rarely make accurate and useful forecasts, i.e. that are not already expected and priced in. What can be said with certainty, however, is that these have been and are extreme times in recent years. Never before has the world been shut down in the same way as during Covid 2020-2021. And never before has there been so much monetary and fiscal stimulus at the same time afterwards to prevent the economic machinery from grinding to a halt. And never before has the valuation multiple on the S&P 500 been as high as January 1, 2022 (and only about 10% lower right now). To emphasize how extreme this is, the S&P 500 is still more expensive than in 1929 and March 2000. The Nasdaq fell more in H1 2022 than ever and then almost broke a record in the rise for H1 2023. These are actually record times now in many key contexts, it's not just what it feels like. It is also almost 40 years since so few companies led the stock market index in a three-month period. According to @GrantsPub, only 23% of the S&P 500, which is the lowest level since the Chernobyl meltdown in 1986.

"So far, so good," says the optimist who has jumped out of a window high up in a skyscraper but hasn't hit the ground yet. Of course, low oil prices and a record-high stock market feel good, but beneath the surface are the effects of at least a 500 basis point interest rate hike in the US in just over a year, against the backdrop of the largest debt mountain and budget deficit in history. Not to mention the veritable earthquake that has shaken the world economy in the form of a START-STOP due to Covid-19. "Don't make hasty moves" is a common saying about complex, organic issues. The global economy and financial markets are just such complex, organically evolved systems with intricate feedback loops. In recent years, humanity has set a world record for rapid movement. So we can also expect record effects, the only question is what they will be. On top of all this, the fourth wave of AI is bubbling up, with different variants of LLM (Large Language) models and their applications. AI development has given momentum to both semiconductor companies like Nvidia and social media companies that control much of the training data LLMs require. On the other hand, it is far from clear how useful this generation of AI tools actually are, i.e. whether they will really increase productivity given the amount of human intervention with qualitative prompting and post-correction required.

In the short term, it is the herd mentality that rules the financial markets. The trend is your friend, in other words. But in the longer term, it is fundamental accounting data that determines prices. In the short term, the stock market is a guessing game, and in the long term it is a scale (which weighs the earnings prospects of companies). For a hundred years, the stock market has always returned within 15 years to a valuation level where the Price / Earnings P/E ratio for the coming year is around 15 and the Price-to-Sales P/S ratio around 1. Another way of putting it is that the valuation has always fluctuated around a level that is consistent with a 10% annual total return over the next 10 years. There is no reason to believe that this has changed, because ultimately shareholders want their money back, plus reasonable compensation for time and risk. Over an economic cycle or two, that has meant just 10%. However, sometimes the stock market has traded at such low P/S ratios that you could expect 20% per year for a decade, and sometimes it has been so expensive that you could expect 0% or even -5% per year. Then, over the next 10-20 years, you have almost always gotten exactly what you could have expected. An unexpectedly strong decade has quite predictably been followed by a compensating weak one and vice versa.

In this context, we are currently in July 2023 at an extreme point in more ways than ever. The only thing really missing to qualify as a true 100-year record is a world war in full swing. But otherwise, as I said, we have new records for debt, central bank actions (QE, QT, rate hikes), price movements (roller coaster for oil, gas, copper, agricultural commodities), Nasdaq's semi-annual movements, valuations (P/S for S&P) and breadth (only 23% outperformers). Is the trend still your friend in the second half of the year, i.e. is it time to stay in equities, mainly semiconductors, social networks, search tools, ad platforms, software and cloud services, or is it time to take a different approach, to dare to think for yourself and deviate from the pack? Maybe it's better to just take a break from stocks and put the money in bonds that, with the US government as a guarantor, yield 5% in USD terms. Or maybe you buy gold as a kind of parking lot. Since the end of 1999, the price of gold has increased 10-fold in SEK from 70 to 700 SEK/gram and there are many indications that the trend will continue. If you still don't want to be fully invested in shares for a period of time, it may be worth remembering that gold has been incomparably better than money in the bank over the past quarter century.

When talking about alternative investments, cryptocurrencies come to mind. Bitcoin and Ether continue to proliferate like mushroom clouds in the world economy, despite countermeasures from various authorities, and their prices have proven resilient to movements in risk assets such as technology stocks. Thus, the optimists are probably right that the next wave upwards could lead to new price records (about 70 kUSD for BTC and 5 kUSD for ETH), perhaps in connection with the next halving in 2025. Some gold, some bonds, some Bitcoin and Ether thus sound like a matter of course in every independently thinking investor's portfolio today. It is a little trickier to say something about the stock part. It is so nice to just run with the herd in the upward trend. After just a day or two, you have completely forgotten about cash flows, valuation multiples, historical patterns, return requirements and theoretical return potential. But, if you really need to maximize your time in the stock market instead of trying to time it, there is the possibility of switching from what has already jumped ahead to what has lagged behind. When one of two historically equivalent strategies has done exceptionally well, it works extremely well to switch to the other. As long as that strategy hasn't been permanently damaged in some way, or the one that has worked well in some way has suddenly become permanently better off after 100 years.

It may be the case that technology momentum has taken on a life of its own and has a long way to go on the upside, that index funds and other momentum players mean that valuation considerations will be delayed for quite some time. But then you build your investment towers on the unstable sandy foundation that some "bigger fool" will buy your shares in the future without any thought of underlying cash flows and actual value. And it may be that high interest rates, dollar shortages, banking problems, Producer Price Index (PPI) rows and a weak CNY do not at all translate into reduced consumption, unemployment and a natural recession that reduces both the demand for companies' products and the valuation of their shares. It may also be that the ESG movement effectively prevents the prices of scarce commodities such as gas, oil and mining products (copper, phosphate, nickel, gold, graphite, carbon, lithium etc.) from rising. It may also be the case that the inflationary impulse passed quickly. However, it is more reasonable to expect that core inflation will, as usual, take hold, that energy and metals shortages will lead to price increases resulting in higher profits and stock prices, and that sooner or later the market will rotate from expensive technology stocks to cheap real assets. When that momentum takes off in earnest, those who dared to go their own way early on get both high dividend yields and price increases. After my conversation with the legendary Marc Faber the other day (published on Antiloop on Tuesday, July 13), I have also become particularly interested in emerging markets, especially Vietnam.

These are new times now. The same new times that always follow extreme actions and developments. New times and turning points from extremes present unusually good opportunities to make good investments. The last 15 years were golden times for virtual products such as advertising, social media, search and cloud services. The next fifteen years could be just as golden for investors who pick the next trend. There are many indications that real assets are in for a great ride: oil, uranium, gold, agricultural products, and motor and battery metals could appreciate sharply relative to all other economic factors - except possibly the leading cryptocurrencies, which may have the potential to move even more (but also have a greater downside risk). Unfortunately, like the pack animals we are, it is almost unbearable to even wait 15 months for the next fifteen years to start. Nothing is more painful than seeing your neighbor getting richer.