Black Swans on the Black Sea

[4 minute read] With the S&P 500 close to its all-time-high set in 2022, it feels like we’re at a crossroads and it’s an important time to take stock of where we are and where we’re headed.

AI printing money? (By DALL-E)

Last year’s market sell-off was driven primarily by fears of rapidly rising interest rates as central banks all over the world frantically tried to tamper a sudden bout of inflation.

It’s been more than a year since the start of rate hikes in the US and the American economy appears unshaken despite being steeped in a period of the fastest rate hikes in history, with rates rising to their highest point in 22 years.

Money is a LOT more expensive today than it was just 14 months ago.

Despite the monetary policy onslaught, the economy maintained a firm footing while inflation cooled. Good news on great news. This has resulted in a breathtaking stock market rally this year.

With the S&P 500 close to its all-time-high set in 2022, it feels like we’re at a crossroads and it’s an important time to take stock of where we are and where we’re potentially headed.

Why So Bullish?

There’s a land war going on in Eastern Europe, interest rates are sky high, the Federal Reserve is letting tens of billions of $$$ run off its balance sheet each month.

There’s a lot to be negative about.

So how is the S&P 500 close to the highs of last year, a time when interest rates were at rock bottom and the Federal Reserve just implemented its first rate hike?

There are a myriad of reasons for this optimism.

For one, as mentioned above, the economy is holding strong. Consumer spending remains robust. Corporate earnings have wobbled but held firm. Bankruptcies are on the rise but attenuated, isolated, and manageable.

Even the most bearish of events in the past year, the regional banking crisis, ended up being a boon for economic optimism. The Federal Reserve demonstrated that it will step in at any moment to stopgap financial disasters and the US’s largest banks even benefited from the crisis by acquiring careening regional banks for cents on the dollar while grabbing major swathes of market share from the (un)fortunate survivors.

Talk about a top-heavy economy.

Finally, geopolitical risks appear to be tapering, with the war in Eastern Europe seemingly grinding to a drawn out stalemate and top US officials traveling to China in June to amend economic relations with the Eastern economic giant.

There’s a lot to be positive about.

What’s Next? (Black Swans on the Black Sea)

In economic parlance, a black swan is an unforeseen adverse event that causes a market crash. Stark examples of black swans in the past include the 2008 mortgage crisis and the 2020 pandemic.

Apologies for the contrived metaphor but I think the market’s current condition can be likened to a duck swimming amongst Black Swans on the Black Sea. In other words, it’s in fragile and vulnerable state.

Why? Because there are many black swans out there that could tank the market, starting with Russia’s recent surprise exit of the Black Sea grain deal that’s instrumental in enabling Ukraine to supply almost 10% of the world’s grain.

War and black swans are a match made in hell, especially when said war involves a major commodity exporter that also happens to be the world’s preeminent nuclear power.

There are other black swans waiting in the wings elsewhere in the world, such as tensions in the South China Sea, the upcoming European winter (which could be frigid and without Russian energy), high inflation in South Asia (India just banned rice exports), and a litany of possible sources of global financial troubles from rising interest rates worldwide.

The global situation is, to put it lightly, tenuous.

Fin

With the S&P 500 close to last year’s highs and the many lurking black swans around the world, may I be so bold as to ask for caution. Just as I write this article, Fitch initiated an extremely rare downgrade of US government debt, citing “expected fiscal deterioration over the next three years”.

Circumstantial evidence, but foreboding nonetheless.