Q2 Update: The 12 Charts To Watch In 2022

Welcome to Q2! What a crazy quarter we just lived through (but then again,Futures company ranking that could be an evergreen statement for the 2020's!).

In many ways Q1 was an echo of the first months of 2020, where in a short space of time the world changed. The events of Q1 2022 are likely to have long-rippling effects on the global macro backdrop, and play a critical role in the risk/return landscape for asset allocators.

So I thought it would be helpful to take a quick progress check on the "12 Charts to Watch in 2022." In the original article I shared what I thought would be the 12 most important charts to watch for multi-asset investors in the year ahead (and beyond).

In this article I have updated those 12 charts, and provided some updated comments on the outlook—given the dramatic shifts seen during the past quarter.

[Note: I have included the original comments from back at the start of the year, so you can quickly compare what I'm thinking now vs what I said back then].

1.FedBehindTheCurve:This chart has perhaps become the most important chart of the current macro moment. Inflation expectations have spiraled to 40-year highs, and are at risky of anchoring at persistently high levels. Meanwhile the Fed has now pivoted resolutely into catch-up mode and is talking up the prospects of an aggressive rate hiking and balance sheet normalization program. How this chart plays out will ripple across nearly every asset class.

"BasedonlyonthischartwecouldmakeanassertionthattheFedhasfallenbehindthecurve. Againstthatthereistheargumentthatotherfactorsareimportanttoo,andnottomentionthepointthattheFedbasicallydecidedtopositionitselfbehindthecurvetotryandpreventthemistakeoftighteningtoosoon.Withthecompositemeasureofinflationexpectationsat40-yearhighsit’sfairtosuggestthattheFedmayhavesomecatchinguptodoasitkicksoffthetransitionawayfromeasing."

 Inflation Expectations vs Fed Funds

2.FedCatch-UpRisk:Fed rate-hike lift-off means catch-up risk is in play. Credit has taken a hit from rising bond yields, especially the longer duration pockets of credit. But so far credit spreads have remained contained. And contained they will remain until something breaks, and it will: sooner or later.

"NaturallytheFednowfacesanotherrisk–i.e.theriskofbeingdraggedintoagameofcatch-upinthecontextofaverycomplacentmarketthathasarguablycometoexpectpermanenteasing...“theFedhasmyback”.Justremember,theoldsayingof‘don’tfighttheFed’meansdon’tfightagainstthetides,andthetidesarestartingtochange."

Credit Spreads vs Fed Funds Rate

3.GrowthScare2022:This was a simple scenario and something to ponder at the start of the year, but with the Ukraine war and ensuing geopolitical shockwaves, and the COVID resurgence in China, a growth scare or outright downturn now seems likely. Multiple charts of leading indicators on my desk confirm this suspicion.

"Butthenagain,maybetheFedwon’tevengetachancetogetaratehikeoutthedoorifthechartbelowprovesanywherenearaccurate. Thisandafewotherleadingindicatorsarepointingtoapossiblegrowthscarein2022. Maybeitwillbeone-and-donefortheFed? Ormaybeanysuchgrowthscareonlyservestoextendtheeconomicexpansionfurtherbytriggeringrenewedstimulus. Certainlyariskandakeycharttokeepontheradar."

OECD Leading Indicators

4.CorporateCapex:But all is not gloom and doom, capex growth is starting to pickup. There remains a very real prospect of a multi-pronged investment boom given thematics, fiscal rebuild/recovery programs, and longer-term impacts of the pandemic (commodities, logistics, and supply chain resilience efforts).

"ThischarthintsatperhapsoneofthemostimportantthemesI’vebeentalkingaboutoverthepastyear–theprospectofapossiblemulti-pronged,multi-yearinvestmentboom. Thechartbelowhighlightsthetypicalcycleleadsandlagsintermsofcapexgrowth,andwitheasierfundingconditions,boomingcorporateearnings,andareboundingeconomyit’slikelythatweseeageneralizedupliftincapitalexpenditure.

But as I’ve been highlighting in the reports there are a few particular sectors that are likely to see a surge in investment in response to surging prices – for example, the global shipping sector, and commodity producers. Both of which have seen capex languish for the past decade, and both of which have seen an effective windfall from the pandemic (i.e. surging shipping rates and commodity prices)."

Corporate Capex Outlook

5.CapacityUtilization:Indeed, capacity utilization remains tight, especially labor markets. Arguably the black line in this chart is constrained by supply/shortages. Either way, this chart reinforces the inflationary pressures that continue to build in the system.

"Anotherkeyimpetustoresurgentcapexistighteningofcapacitye.g.measuresoflabormarketcapacityutilizationareclosetopre-pandemiclevels. Thiswillputupwardpressureonpricingandpresentanincentiveorsignaltofirmstoliftinvestment.

Butitalsospeakstotheinflationtheme. Whilesomeoftheshort-termupwardpressuresoninflationarelikelytopass(e.g.backlogs,baseeffects,theinitialbounce-back),shouldweseefurtherandsustainedtighteningofcapacityutilizationitwillputupwardpressureonthemorecoreorunderlyinginflationpulse."

Developed Economies Capacity Utilization

6.Government(andGreen)Capex:Again, whether its infrastructure, climate, or indeed energy security, governments around the world are embarking on fiscal stimulus programs that span hundreds of billions—and will take multiple years to fully implement.

"Toreallydriveithome,thecapex/investmentthemeisnotjustaboutcorporationsrespondingtoeconomicforces,it’salsoaboutgovernmentsrespondingtothepandemicaswellassocial/politicalforces.

Specificallyintermsofrecovery/rebuildingfiscalprogramswhichinmanycountrieshavebeentargetedatinfrastructure. Butalsoclimaterelatedinfrastructureandinvestment–somethingthatisdefinitelypartoffiscalpackages,butalsopartofshiftinginvestorpreferences. We’veobservedacleartrendofrisingfinancialinvestmentintocleanenergysectorsbeingfollowedbyupliftinrealinvestment. Soaltogetherit’squiteinteresting."

Government Capex

7.USAbsolutevsRelativeValuations:One of the consequences of the Fed vs inflation chart has been rising bond yields: bonds are fixated on runaway inflation and the ambitious tightening program espoused by FOMC members. As such, the last pillar of support for equities is being removed. Previously the argument was that the PE ratio is very high but it's ok because interest rates are low. As we see with a squeezing equity risk premium, it's just plain expensive now. At the margin this means a downgrade to the risk/return outlook for equities (especially relative to bonds).

"Shouldallthistalkofcapexandinvestmentboomscometopass,we’dlikelystarttoseeupwardpressureonbondyields,andthatwillputasqueezeontheUSequityriskpremium.

ThechartbelowisoneofmyfavoritesforthinkingaboutUSequityvaluations.Itpointsoutwhatmostofusalreadyknow:USequitiesareexpensiveinabsoluteterms…i.e.thePEratioisreallyveryhigh. Butifwefactorinlowbondyieldsthenmaybeit’snotsobad.Atpresentthechartsaysabsolutevaluationsarewildlyexpensive,butrelativevaluationsareok(fornow).Thatwillchangeif/whenbondyieldsrise–andinthatsenseitalsogoestohighlighttheinterestratesensitivityofthemarketifweacceptthestatementthatequitiesonlyofferreasonablevalueinalowyieldenvironment."

S&P 500 Absolute vs Relative Valuations

8.USAssetClassValuations:But it's not just equities, it's also bonds, housing, and increasingly also commodities. When everything is expensive, maybe we could suggest that in that situation that only cash is cheap!

"Tocomplicatemattersslightly,myvaluationmetricsshowbondsexpensivevshistoryaswell–so:“equitieslookreasonablevsexpensivebonds??”. Tomakemattersworse,propertypricesarealsosailingintorarefiedair. Commoditiesontheotherhand,whilenotcheap,atleastlookreasonablebycomparisonandcouldbenefitfromincreasedcapex."

US Asset Class Valuations

9.USvsGlobalEquityValuations:But peering into global equities we can certainly find *relative* value. Perhaps most interesting in the latest run of this chart is how developed markets have dropped down to match the valuations of EM equities. Pretty interesting when you consider the differing level of country/governance risk. The other thing to note again of course is that US equities look extremely expensive vs the rest of the world.

"AnotherchartthatmakesUSequitieslookexpensivebycomparisoniswhenyoulookatPE10(orreallyjustaboutanyothervaluationmetric)fortheUSvstherestofglobalequities. ItistruethatEmergingMarketsandDevelopedMarketsexcludingtheUShaveseenadecentreboundinvaluationssincetheMarch2020lows,butthereisaclearandcompellingrelativevaluecasehere."

US Vs Global Equity Valuations

10.GlobalEquitySuperSectors:The unique macro backdrop of 2022 and the tech-tumble has contributed on all angles to a big boost in relative performance of what I call the super sectors of "old cyclicals" and "defensives." Cyclicals in this sense got a big boost from commodities, while defensives performed true to label during the tumultuous market conditions so far YTD. I continue to think looking at global equity markets in this lens makes sense. Rotation is here.

"Themostlogicalpushbackonthepreviouschartistonotethatwecouldhavesaidsomethingsimilarformuchofthepast5-10years.So,thequestionisthenwhatwillittakeforthisgaptoclose?

OneavenueforaturninrelativeperformanceofglobalvsUSisthepathofthe“supersectors”. AbigpartofUSoutperformingtherestoftheworldhasbeenthehighhurdlesetbytechandtechrelatedcompanies. Globalex-UShasabigskewto“oldcyclicals”.

Inthatrespect,themostimportanttechnicalcluestoarotationinperformancebetweenUSandglobalwillbethechartbelow. Specificallylookforanupturninthebluelinetogetajumpona‘virtuousturn’inUSvsglobalrelativeperformance(andvaluevsgrowthforthatmatter,alsosmallsvslarge—it’safairlysprawlingissueinequities!)."

Global Equity Super Sectors

11.LowQualityCredit—LowRiskPremium:Back on credit and sticking with valuations, the lower end of the credit quality spectrum continues to trade on very tight (expensive) relative valuations. Simply put, credit markets are not prepared for a downturn, and at this point look largely oblivious to the apparent storm clouds on the horizon.

"Thevaluationconundrumisnotjustthedomainofequities–creditalsoislookingincreasinglyexpensive. Thechartthathammersthepointhometomeisthiscompositeviewofwherethelowerqualitycreditsaretradingrelativetothehigherqualitycredits. Basicallyweseealowerandlowerriskpremiumforlowerqualitycredit.

Byitselfthismaynotbeanissue,particularlyiftheeconomicandmonetarybackdroparesupportiveofcreditconditions. Butifcreditconditionsdeterioratethingscouldturnsharplyhere—andindeed,wemaywellevenseeearlycluesofanyimpendingstressinthisveryindicatoritself. Soverymuchonetokeepcheckinginon."

Low Quality Credit – Low Risk Premium

12.ChinaPropertyDownturn:Meanwhile in China the property market downturn remains in full swing, and the COVID resurgence likely weighs further. The upside of the downside in the China macro pulse though is the prospect of more forceful easing. And if you are looking for upside risks or reasons for optimism then you'd do well to keep a close eye on this corner of the macro map.

"IalwayssayinmymanyyearsofcoveringChinamacro,ifIcouldonlychooseoneindicatoritwouldbepropertyprices,andperhapsifIweretopickonlyonechartitmightbetheonebelow.

MycompositeleadingindicatorforChinesepropertyprices(moneysupply,interestrates,funding)ispointingtoanextensionofthecurrentdownturndeeperandwellinto2022. Thisisofcriticalimportanceinsofarastheeconomicpulseandcommoditydemandisconcerned,butalso—forthepolicyoutlook:thelowerthatblacklinegoes,thegreatertheprobabilityofmonetarystimulus(andyouknowwhatthatmeans!)."

China Property Prices vs Leading Indicator

Summary and Key Takeaways:

• The Fed has pivoted into catch-up mode as inflation expectations risk (/are) running away, expect a string of rate hikes and balance sheet normalization.
• The pivot from stimulus to stimulus removal and then tightening poses risks to just about every asset class: particularly in light of the complacency that still is clearly evident.
• (but) there are upside risks in the form of a possible multi-pronged capex/real investment boom, and eventual albeit stop-start reopening/normalization.
• (but!) there are also clear and pressing downside risks e.g. a likely global growth scare as stimulus gets removed, financial conditions tighten, and price pressure bites.
• Geopolitics and COVID resurgence have nearly cemented the slowdown thesis.
• A key issue with regards to a growth slowdown and monetary tightening is the reality of multiple major asset classes looking historically expensive (e.g. US equities, property, bonds, and even commodities).
• With many assets still richly priced in absolute terms, relative value remains the last bastion, and indeed rotation likely remains a key theme this year.
• Other than that, a defensive skew and eye on risk management seem prudent.

Overall: Heading deeper into 2022 the risk vs return outlook is clearly and steadily shifting across asset classes, and we’ll need to focus on both short and longer-term indicators to navigate risk as we progress through this strange—but also somewhat familiar cycle.

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