Mixed Signals

by | July 5, 2021

When teaching economics, instructors find it useful to invoke ceteris paribus—all else equal. It is a strong but useful assumption, enabling students to understand how various economic outcomes are affected when only one input is changed (holding all else constant).

Unfortunately, the real world is messier than the classroom. Lots of stuff happens and, inconveniently, often at the same time. 

That’s very much been the case during the pandemic. In the parlance of economists, Covid-19 and its aftermath have unleashed simultaneous supply and demand shifts. Compounding matters, the slopes of the supply and demand curves may have changed as well, creating puzzles about how ‘elastic’ production, labor demand or labor supply may be to higher prices and wages. And given the well-known tendency of economists to bicker, it should hardly be a surprise that debates have erupted about whether the economy is undergoing transitory adjustments or more lasting shifts.

Investors might prefer the luxury of letting economists duke it out at a safe distance. But they can’t—finance is merely a branch of economics. Asset prices are determined by supply and demand. Their ability to convey clear signals is compromised by the same challenges that bedevil economists.

Instead, investors are increasingly confronted by inconclusive and conflicting data. For instance, after racing ahead for most of the year, lumber prices have recently tumbled 40% from their peaks. Yet other commodity prices, such as those for oil and coal, continue to surge and make fresh highs. Broad commodity indices hovers near their post-pandemic peaks. Is lumber signaling a top for raw materials prices? Or is energy poised lead a commodities breakout to even higher prices?

In the US, house prices are soaring. Yet perhaps as a result, home sales are showing signs of stalling. The latest construction spending figures disappointed consensus expectations. Are consumers balking at ‘sticker shock’? Or are builders frustrated by lack of materials and labor? 

Globally, indices of production also appear to have peaked. Chinese and US surveys of manufacturing have come off recent highs. What remains to be seen, however, is whether manufacturing is being held back by temporary parts and supply shortages, perhaps even transportation bottlenecks. US auto production, for example, remains gummed up by a shortfall of computer chips. Backlogs at ports and onward distribution nodes have slowed international shipping, in some cases by several weeks.

In labor markets, job growth has picked up, but so too have resignations. In April, nearly 4 million Americans quit their jobs, the highest number ever recorded by the Bureau of Labor Statistics. Some may be testing a buoyant job market for higher pay, but others may be disgruntled, taking early retirement or unable to find childcare. In the most recent US employment report, a higher-than-expected 850,000 new jobs were created, but most were in lower-paying hospitality, leisure and government sectors. Elsewhere, job growth is more pedestrian, which may reflect a scarcity of skilled candidates and other labor market mismatches. And despite soaring job openings and faster wage growth, the US labor force participation rate remains mired at 61.6%, well below its pre-pandemic level of 63.4%. Total US employment is still nearly seven million workers short of where it was before Covid-19 arrived. 

To repeat, the pandemic unleashed simultaneous demand and supply shocks. Also, pandemic disruptions to global production and distribution came directly on the heels of trade wars, Brexit and slowing globalization. Now, as global demand rebounds amid economic re-opening, the supply response is sluggish in many places, including energy, manufacturing, shipping and labor markets.

Confronted with mixed signals, economists dig deeper into the data and recalibrate their models. 

Investors, on the other hand, cut risk. Over the past month, market participants have pared back their expectations for growth. Nominal bond yields have dipped, and the yield curve has flattened, even though expected rates of inflation have edged up. Equity investors have shifted away from more cyclical sectors and styles back toward stocks that promise reliable growth, such as information technology or healthcare companies. The dollar has regained its footing, typically a sign that investors are becoming more risk averse. 

Still, investors are not cutting overall exposures to equities. Mostly, that’s because returns in bond markets or cash are unappealing, particularly as inflation erodes interest payments. 

Investors could get burned. The upcoming second quarter earnings season, which kicks off later this month, seems likely to deliver bumper profits for sectors that benefitted most from economic re-opening and surging demand—precisely the cyclical stocks that have recently fallen out of favor. Timing markets is never easy, but this looks to be a particularly challenging moment for active managers whose performance is scrutinized with unrelenting frequency.

Shall we pity investors and active managers? No, others are more deserving of our compassion. But it is nevertheless worth acknowledging that those who manage our assets are confronted today by an unenviable confluence of shifting fundamentals and mixed signals. 

Economists have the luxury of sorting it out after the fact. Investors are tasked with doing their best in real time. We wish them both well.

About the Author

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy.

Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland.

From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT.

At both GAM Investments and UBS Investment Bank Larry was widely recognised for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others.

Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

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