Some Reasons for Optimism

April 25, 2022

4 minute read

Insights and Market Perspectives

AMID THE GLOOM AND DOOM over geopolitics and inflation, we begin this week with a contrarian look at reasons for optimism. The stock market may stay shaky and volatile into the summer, but no trend lasts forever.

A CLEAR REASON FOR OPTIMISM THIS MORNING is proof that NATO is unified against Russia, thanks to Emmanuel Macron’s easy 17 point win in yesterday’s election. Vladimir Putin has unified the alliance better than anyone (especially him) could have imagined.

RUSSIA BOGGING DOWN: The destruction and slaughter in Mariupol only makes the civilized world angrier; it cannot be described as a victory for Moscow. We’ve said this before and will say it again: Russia cannot win this war. And there are signs that the Russian advance in the Dombas region may be bogging down.

REUTERS REPORTS THIS MORNING that the U.K. Ministry of Defence, known for accurate intelligence reports, concludes that “poor Russian morale and limited time to reconstitute, re-equip and reorganise forces from prior offensives are likely hindering Russian combat effectiveness.”

THEN THERE’S THE EXTREME OVER-REACTION to the Federal Reserve’s tighter monetary policy. It was stunning to see the markets react so nervously last Friday; was it just dawning on investors the Fed is serious about inflation? Has the market been too sanguine despite weeks of warnings? “No, stubborn,” quipped our head trader, John Chritofilos.

THE FED WILL TIGHTEN MORE, BUT MONETARY RESTRAINT IS NOW IN THE MARKETS: Any sign of economic moderation or a deceleration of inflation could produce 25 basis point rate hikes by fall, not 50 per meeting. Anecdotal evidence from the shipping world points to solid but not red-hot growth.

ANOTHER REASON FOR OPTIMISM, AT LEAST FOR THE MARKETS, is the very slow pace of regulatory reform. Only one key regulator has been confirmed by the Senate — Gary Gensler at the SEC — while two other big posts remain vacant: the chief of bank supervision at the Fed and the Comptroller of the Currency. Antitrust policy has been more bark than bite.

AND — SURPRISE — THE BUDGET DEFICIT IS PLUNGING: With little publicity, the cumulative deficit for the first six months of fiscal 2022 was about 60% lower than it was through the first six months of fiscal 2021, reflecting a $620 billion decrease in outlays and a $418 billion increase in revenues.

REVENUE GROWTH has been remarkable; individual tax revenues are up by 36% for the first half of this year, compared to fiscal 2021. After a $3.1 trillion deficit in fiscal 2020, followed by a $2.77 trillion deficit in 2021, red ink in this fiscal year could be around $1 trillion. It could be below 10% of GDP; it was 15.6% just two years ago.

OBVIOUSLY DEFICITS ARE STILL HIGH, but the speed of this decline is astonishing. And with Republicans likely to capture the House and perhaps the Senate in November, the phrase “fiscal drag” may return — which of course would be bullish for the bond market.

BOTTOM LINE: Obviously, there are many things to worry about: Vladimir Putin’s viciousness, Covid variants, the Fed over-doing its tightening, etc. The one thing we don’t worry about is an over-heating economy; the froth will be extracted in the next few months.

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This post was first published at the AGF Perspectives Blog.