The Forward Price of Economics
Recent experience in market investments has moved down from the highs as a new economic reality takes over. Material shifts affecting economic activity are not limited to but include the Ukrainian crisis and record inflation that warrants a more restrictive role of money in the marketplace. As a result of the sheer amount of change, economic uncertainty has soured stock market returns. Economic participation is partially an exercise in psychology that requires investors to do something uncomfortable and not ingrained in the human psyche, namely, manage uncertainty.
The global economy may have now come upon a period of new challenges. On the one hand, ongoing labor and product shortages and higher commodity and labor prices can lead to more constraints in the trade of physical goods and services. On the other, a slowdown in the creation of financial capital would lessen the rate at which new and current companies can finance new sources of growth. In short, both can work against the rate of expenditure growth on a global scale.
The Ukrainian crisis is yet another development that impedes economic prosperity, peace, and stability. Furthermore, due to the Russian invasion and economic sanctions enacted against Russia, certain earth minerals, energy supplies, and agricultural products are in short supply but remain in high demand. The thought of a prolonged conflict on the Eurasian continent is one more reason why global inflation could persist longer than initially planned.
A problem with sustained inflation in commodities is people’s inability to reduce consumption when prices increase. In non-essential channels of consumption, consumers will lessen their expenditures and consumption on a particular good or service when prices rise. That's the implication when economists say consumption demand is elastic to price. However, in the case of food, energy, transportation, and shelter, it's not easy to cut out consumption in the essential categories required for life. In other words, when inflation runs high in the basic needs of life, the result can act as a tax on the economy because it can remove spending from other economic sectors. Lastly, commodity inflation induced by wars and other non-monetary factors is outside the models of even the best theoretical ideas for regulating inflation.
However, a coordinated effort to regulate global inflation is in motion. For instance, the European Central Bank recently joined the Federal Reserve Bank to taper down the rate at which financial capital grows in marketplaces. As a result, short-term interest rates on European bonds have shifted upward, similar to how US short-term bonds moved higher near the beginning of this year. A slow down in the pace at which monetary reserves grow can slow activity that brings new debt and equity to markets. Based on volume, capital deals in global markets are already down in 2022 compared to recent periods. When a smaller amount of new capital comes to market, there is less validation for current investment valuations.
In the context of increased inflation, moderation in the number of corporate deals is leading market prices to a new state of equilibrium. Specifically, the rerating process of investment values is generally more easily seen in the markets for corporate interest rates. It is quite apparent that the interest rate premium corporate debt pays for risk has risen in domestic and foreign markets.
Thus far, this month's narrative speaks of a slowdown in economic activity due to causes tied to inflation and capital formation. Such adjustments in the global payment system seem natural given that opposite tools were used in the pandemic: drive capital formation to prevent global deflation. Now economic activity is put in a position to operate on the other side of the same coin. But unfortunately, wars and sanctions make the picture murkier. These are all likely reasons for the stock markets decline since the beginning of the year. But it is important to remember that stock prices anticipate future economic change. Short-term volatility is normal for equity-related investments and usually commensurate with the long-term gain of owning stocks. Further, events that may seem catastrophic are often quite common. There is no guarantee of future positive returns, but the past offers a rich history of short-term risk that lives in stocks and the resulting long-term growth that often follows.
