No Organic Growth

One of the habits of financial markets is extrapolating short term trends well into the future.  Remember 2021, when the Fed was assumed to be stuck at zero until 2024 and financial repression would continue for years and years?  Now in late 2022, almost everyone assumes that the Fed will be higher for longer, keeping rates at a restrictive level for all of 2023 and well into 2024.  Its a bizzaro world out there.  Rear view mirror forecasting while ignoring the prior misses using that same forecasting method. 

In order to maintain restrictive rates for a long time, there needs to be growth. Where will the growth come from?  The fertility rate is steadily dropping in the G7 nations and China.  The main source of world population growth, Africa, is basically an economic non-entity.  Here is the population growth rate for the US, the big 3 in the Eurozone (Germany, France, Italy), and China since 1970.  

United States population growth rate

Germany population growth rate

France population growth rate

Italy population growth rate

China population growth rate

Notice the steady downtrend for the past 5 years for all of the countries above.  The U.S. population growth rate is now around 0.3%/year.  Immigration has dropped dramatically in the U.S.  In Germany, France, and Italy combined, there is negative population growth.  China has steadily declined and is now at 0, and falling the fastest of them all.  In all the above populations, the demographic is getting older, reducing the current labor force and potential labor force in the coming decade.  Its a recipe for very low growth.

The GDP equation is as follows:  

The 3 key inputs for GDP growth are productivity, capital, and labor.  With work from home and an aging population, with no new breakthrough technologies since the internet, productivity is flat to down.  Capital is no longer cheap or readily available with the Fed jacking up interest rates and reducing the money supply.  And with an aging population and near zero population growth in the biggest economies in the world, there is no growth in the labor force.  Basically, you have zero GDP growth without a surge of cheap capital in the form of fiscal and monetary stimulus.  Without stimmy, no growth.  Its that simple.  

Secular stagnation is the baseline, and whatever artificial means are used to shake the patient from its stupor are the exceptions, not the rule.  The 2020-2022 economy running high on stimmy is over.  Sure, there will be stimmy coming back, because populism is here to stay, but its not coming back in the US anytime soon.  With gridlock until the end of 2024, the Republican base will not help Biden/a Democrat get re-elected by pumping the economy.   So odds are very low for any new stimulus in the next 2 years.  That's 2 years of being drug-free for this stimmy addict of an economy.  The withdrawal pains are being vastly underestimated.  The patient will be screaming for another dose to get rid of the hangover as he's crashing down from his biggest rush ever.  

I am sympathetic to the secular inflation case because odds are high that the politicians will keep going back to that money well when things get hairy, and that will ensure future inflationary waves.  But since inflation is a rate of change statistic, it will not stay at a high level for long if the governments and central banks aren't continuously printing.  And the coming downward cyclical forces are so strong that it will overwhelm the structural energy supply shortage. 

Without the buffer of a naturally growing economy from population growth and/or productivity growth, the economy will not be able to handle a Fed funds rate at 4-5% for long.  Its already showing signs of weakening and Fed funds isn't even at 4% yet.  Powell who is smarter than he sounds, is just following the safest path politically, which is to act like an inflation fighting hawk when inflation rates are high.  He needs an excuse to change his rhetoric, either in one of 3 ways:  1) a big drop in stocks/blow out in credit spreads 2) a much lower CPI 3) much weaker nonfarm payrolls numbers.  

I thought a big drop in stocks or a much weaker credit market would be the first thing to break, but they have held up well, as investor psychology is still very much in a buy the dip mentality.  So it may have to be much weaker nonfarm payrolls numbers that gets the Fed to relent from its hawkishness.  The CPI works with an even bigger lag than the NFP, so its going to be the last thing to show that the economy is in a recession.  Considering how important housing is to the economy, the higher yields will have a much bigger effect in 2023 than currently, as the downstream effects of a housing freeze will flow through to construction and durable goods demand.  This will have a notable effect on the jobs numbers in the coming months.  

I hear many five minute stock market experts calling for a year end rally, talking about how underperforming fund managers will be chasing for performance, talking about positive seasonality, etc.  Valuations are still too high considering the high level of yields.  The fundamentals are horrible.  Shorting overvalued tech stocks around SPX 4000 feels like shooting fish in a barrel.  Looking to reload on tech shorts at higher levels as the Thanksgiving holiday cheer tends to get investors bullish.