Three market uncertainties
Every moment seems especially uncertain when you are living it. It is always an illusion. In the shadow of several elections and a couple of wars, with central banks pivoting and equity markets on an unusually long bull run, late 2024 may feel especially dangerous. One way to remember that risk is just the water we swim in is to enumerate and describe our uncertainties. It makes them feel tractable.
What follows are my three big questions, and my guesses at their answers. I choose the word “guess” deliberately. Confidence in the answer would knock the question off the list. Another required feature of a question is temporal specificity. Of course I’d like to know what GDP or CPI will be in a year’s time, but I always want to know that.
Here’s what I lie awake at night thinking about:
Is there a level for the 10-year Treasury yields that will crack the equity markets, and are we going to hit it sometime soon? To generalise wildly, stocks don’t like high and rising yields because they represent tightening financial conditions and they compete with stocks for capital flows. The recent history of the 10-year Treasury yield and the S&P 500 shows the tension:
Unhedged’s guess: Yes and yes. The market is pricing in a decline in rates, and stocks are expensive enough that investors will be looking for an excuse to reduce risk. At the same time, inflation is not going quietly; president-elect Donald Trump’s policy promises don’t seem likely to help with that. A crash seems very unlikely — there is still too much global liquidity around for that. But a meaty correction (something like late 2018?) seems eminently possible.
Are we in a credit cycle? And, if so, what part of it? Corporate bond spreads over Treasuries are about as tight as they have ever been. In a normal world, that is consistent with late-cycle prosperity, suggesting that spreads’ next move is up and it is time to reduce risk. But are we still in post-pandemic suspended animation? Or is this actually a recovery? Opinions on Wall Street vary.
Unhedged guess: No. Cycles begin and end with downturns, which “reset” markets by wiping overleveraged players and forcing a general repricing of risk. There was no real downturn this time, because fiscal policy prevented it. It will take another downturn to return the economy to a cyclical pattern. Until that happens, history will be a poor guide to economic conditions.
Is AI a bubble? AI is going to change everything. There are a handful of companies that have the resources to invest in the technology. So maybe those companies are the ones that develop profitable AI products. And maybe most companies will get a productivity boost from AI’s automation of white-collar work. If that’s true, there’s no bubble, and so there will be no pop.
Unhedged’s guess: Yes. Railroads and the internet changed everything, too, but their first manifestation was in bubbles that burst. The combination of the fact that AI is obviously an amazing, important thing, and the fact that we don’t really understand how it will work as an industry, makes it absolutely perfect bubble fuel. AI hype has loads of room to run, and there will be a reckoning at some point. But you can’t know when, so you can’t trade it. You probably can’t even get out of the way. Buckle up, everyone.