Is a New World Paradigm Shift Coming Again?

Is a new world paradigm shift coming again? After Covid hit us in 2020 and caused the world to turn upside down, is 2022 the year of reckoning that things are afoot where the world we knew previously is in for a dramatic change again?Or are we just reverting back to the long-term norm that was missing for the last 14 years due to years of excesses. Is pandemic shock a slap in the face and a wake-up call?

In hindsight, the current runaway inflation was bound to happen in 2022 anyway, as we revert back to normal. It is logical to assume that after the significant drop in demand (-90%, Lockdowns) when Covid hit us in Mar 2020, we would be looking at a much lower starting base before things start to turn around in late 2021 (vaccine rollout, milder and less deadly strains of Covid).

If the 2022 recovery even goes up to 50% of the 2019 level, it would have been multiples of the low base established in Mar 2020. This inevitably leads to huge inflationary pressure upwards as demand surges this year back to pre-Covid levels. The Ukraine war that started in Feb was the tipping point that choked supply chains and made the situation worse.

The Fed has been blamed for being behind the curve on interest rates and hence the current aggressive hikes. But it is easy to point fingers at Powell. Economies were just slowly recovering from the pandemic in late 2021 after huge amounts of money were printed by most governments to ensure that their jobless citizens could pay their bills and have food on the table while being locked at home throughout 2020.

If they had pulled the trigger to raise rates too soon, it would have sent the economy back into a downward spiral. Given that Fed meetings do not occur frequently (only 8 in 2022), they only had few windows of opportunity to fire the silver bullets. The signalling message to manage the expectations of the markets is also tricky and not easy. But once the hikes started, there is no turning back as the inflation monster had already raced ahead and broken down the barn door.

If we look back into history, the long-term trend of interest rates should be hovering around the 3 to 5% range. No thanks to the 2008 GFC, central banks have been artificially suppressing the rates to all-time lows (ZIRP – Zero Interest Rate Policy) and even to negative regions, something never heard of before.

This started a 14 years binge on cheap borrowing costs that created many asset bubbles. The era of cheap money encouraged leveraging and borrowing to the max. Money makes money and using OPM (Other People’s Money) was the rallying call to become rich fast. Look at properties. Put a small downpayment, borrow the rest at 1% and try to get a rental yield of 2% or more. With leverage built in, that 1+% positive carry can easily result in 10x returns. Then use the property as collateral to borrow again for another new property purchase and repeat ad nauseam.

The Gamestop saga, cryptos and NFTs in 2021 were the final straw that broke the camel’s back. There was so much quick and fast money to make that everything looked like a Ponzi scheme but the new “financial” experts touted it as the “new normal” investment strategy. Get in as fast as possible and try to get out asap for the next new Bored Apes NFT game in town. Greed played a big part to discourage logic to fuel the addiction to remain in the game.

I seriously think that this era of excesses is coming to an end now. The aggressive rate hikes are rapidly bringing us back to the long-term interest rates norm. All stock prices including the darling tech companies of Covid have dropped 70-90% from their all-time highs. Crypto market cap valuation has erased 2/3 of their value from $3 Trillion to less than 1 now.

Where do we go from here? The world is heading to an inflexion point by early 2023. Do we bite the bullet and put on a brave front to fight the possible recession to cure ourselves of the years of excesses? Or do we bend the knee and go back to the happy days again of more money-printing addiction? It is a political hot potato that can swing either way.

I see the world returning to the old normal pre-2008. It swings in an opposite way in 2022 to deflat the 14 years old bubble. The abrupt adjustment meant that most asset bubbles have deflated rapidly, mainly stocks and cryptos. The pandemic was the trigger point to bring the era of cheap money to an end. Thanks to technology and social media, market swings are more sudden and violent. They can happen very fast (eg. Mar 2020 upswing). What took many years to form may be reversed in a matter of months.

Inflation was hiding all along in various asset classes. While technology might have dampened it with advances that improved productivity, there was a spill over into many other areas. The Fed has to now tame the raging inflation bull by the horns. The aggressive rate hikes should taper off soon as there are signs that prices may have peaked and plateauing.

The final 60 days of 2022 will see reduced liquidity that will mean more wild swings in all markets. It is a day trader’s dream market but a nightmare for value investors. If intraday trading is not your thing, then one should have a top down approach and try to crystalize the macro big picture to trade on the higher probability trends. USD to remain strong due to higher rates, park some cash in short term instruments like T-bills to prepare to buy selectively into 2023.

For the brave, it could be time to slowly accumulate shares of companies that has a sound business model which is much cheaper now. We will continue to see great volatility till the end of the year. Time to study the preferred stocks and nibble at them into 2023. There will be more negative news coming but we should take it as an opportunity to accumulate more.