Falling stock prices are a good thing

The S&P 500 is down some 20% from the December ‘21 peak. This no doubt partly reflects various supply disruption and nuclear holocaust scenarios associated with the NATO-Russia proxy war in the Ukraine. However, given the proximity in time of recent (last two weeks) stock declines with Fed statements, we can be confident much of the draw down also reflects a tamer market forecast for nominal spending growth.

Basically, “the world is is a mess”, and also the Fed seems to realize the flow of spending has been a little too strong, and was on track to by far too strong, so stocks are down. The Fed is now expected to slow the flow of spending a little, less money flowing, lower nominal profits, lower stock prices. Import assumption here: the Fed controls the path of nominal spending in the USA, in the same manner that a dog walker controls the path of a dog: not with total precision, but certainly enough to say the walker sets the “policy path”.

The Fed should never have allowed the market’s implied nominal GDP forecast to get so high. In 2021 Q1 we might have expected 6% or 7% nominal GDP growth for 2022 and 2023, when the appropriate figure would have been more like 4% or 4.5%. This said, there’s really no cause for worrying about recession currently. Copper prices (powerful forward indicators, not much affected by the SMO) are still super strong, and 5-year breakevens imply about 3% CPI inflation, averaged over the coming 5 years.

In closing, I’ll leave you with what I consider the likely “best we can hope” for and “worst we need fear” scenarios. It could be even better or even worse of course, but these are what I consider bounds on a 95% probability interval.

Plausible good scenario

The NATO complex contents itself to do mostly pro forma aid to the Ukraine, as cover to loot the US tax payer and hobble its European vassals. Russia accomplishes her goals in the Ukraine by October, and things cool down. Various fig leaves are found to allow Russian commodities to continue flowing into the global economy. The Fed gives us 3.5% NGDP growth in 2022 and 4% in 2023, life goes back to normal.

Plausible bad scenario

Tensions with Russia are inflamed further. NATO installs missiles in Finland, Russia launches missiles at Finland. Russian commodities are meaningfully hindered from flowing into global markets, a strong supply side shock freaks out the Fed, who sends the USA into a nasty 2008 style recession in order to get better CPI statistics. There are lots of job losses.