2023-10-06 Markets

The last couple of weeks made us feel like we returned to the horrible 2022: both equities and bonds were down and in a significant way. But there is a big difference: 19 months ago official interest rates were more than 5 percentage points below today’s in the US, similarly in other countries, and this must mean that we are closer to the end of the tunnel – no matter how long the tunnel is. You can feel this because markets appear fully focussed on one single issue: when will rates begin to come down? Nothing else seems to matter much. The impact on equities, which remain overvalued, is less relevant than that on bonds: if it’s true that we must be by definition closer to the end of the tunnel, why are bonds still doing poorly? The explanation I prefer is the one advocating the presence of a strong supply/demand imbalance: the excess supply of bonds (government deficits are growing and potentially can grow further if the global economy slows down) is big enough to offset the positive effects of inflation (which lowers the real value of debt) and economic slowdown. One case in point is the US, arguably the most dysfunctional nation in the world today, where both debt- and interest-to-GDP ratios are going up together for the first time in many years (see graph below, by Goldman Sachs Research).
     The sign in the cover picture was hung in the guest parking area of the house in Küsnacht where we rented an apartment for 14+ years. It was an inside joke between the owner of the building and some of his friends, like those cartoons in The New Yorker which are a little too New York-based for outsiders to get. Maybe the owner wanted to make sure everybody knew what car he drove.
[Cover: author’s photograph]