Hello and welcome to our latest video MacroMemo, and there’s plenty to cover off in the economic sphere these days.

We’ll acknowledge inflation that’s been coming down a little bit, which is wonderful news. We’ll talk a bit about the U.S. midterm election, how things are shaking up as the votes are counted. COVID-19, it needs a little bit of attention, though I hope not for too, too long.

And we’ll then pivot into the economy. We’ll talk about some mixed economic signals that we’re seeing. We’ll talk about the tech sector and to the extent that weakness there might or might not be a leading indicator for the broader economy. We’ll take a look at what the recession signals we’re tracking are saying right now.

And we’ll also spend a bit of time on some special topics, including cryptocurrencies; the recent weakness of the U.S. dollar after a long period of strength; the situation of natural gas in Europe and the extent to which inventories have built quite nicely there, actually; and then also some of the takeaways from the COP27 Climate Change Conference that’s just concluded in Egypt.

Let’s jump in and start with the most important economic subject, which is inflation. It’s been the big problem out there. It’s been the thing that’s been driving the economy downward, driving central banks higher, and creating all sorts of problems, and so we want to get this right.

And so, it was a pretty big deal when U.S. inflation for October came out and was quite a bit weaker than expected, quite a bit softer than it had been in prior months. In fact, core inflation rose by just 0.3%. That’s not weak in any kind of absolute sense, but it’s much lower than we’ve seen for a while. And so it was a happy development.

It’s a second month of weakness; not consecutive. You have to go back to July to get that other month of weakness, but two out of the last four months have now shown some softness.

We fully expect inflation to remain choppy from here. It’s probably not going to be a smooth path lower, but we’re gaining some credibility to the view that inflation is starting to turn here.

We think the theoretical arguments are quite sound. Supply chains are getting better. Commodity shocks are fading. Central banks have turned. Fiscal policy is less generous. It makes sense that inflation is coming down. It’s nevertheless really nice that it actually is starting to come down.

We think it can continue to fall. In fact, we think inflation can be a little bit below consensus next year, which is good news in terms of central banks having to tighten a bit less and maybe markets being able to rebound a little bit more than otherwise imagined.

One twist is that other countries outside the U.S. aren’t fully partaking in that improvement yet. And so, for instance, Canadian inflation in October was still fairly hot, as it was in Europe and in the UK. Some are worried maybe the U.S. is on a different track because its strong currency is allowing for lower inflation rates. The U.S. is importing deflation, you might say.

I don’t think that’s the main story. It does explain a little bit of it. It’s not the main story, though. There does seem to be some genuine theoretical support for other countries getting lower inflation as well. And indeed, places like Canada also had a nice soft month in July, so it is possible to see that. We think those other countries will start to see some weaker inflation, too.

We do need to start looking forward, though, and not just backwards. And so as November rounds to a close, as I record this, we can say that the November inflation numbers are looking not bad in the sense that oil prices have come down in the month of November, and so that’s a key determinant. We’ve seen money supply growth also softening in a way that would normally suggest inflation gets to continue declining. So we don’t look for inflation that’s quite as low in November as it was in October on a month-over-month basis. We do think, though, it will still be a helping hand to getting the annual figures somewhat lower.

Let’s talk now politics. The U.S. midterm elections were concluded a couple of weeks ago. You’d think that would all be old news now. However, it’s taken a long, long time for the results to be tabulated. In fact, they’re still being tabulated, but we now know enough to actually say with some precision just which party at least won the House and the Senate.

And so it appears the Senate has stayed in Democrat hands, even though there is still one more runoff election to occur in early December. The House of Representatives did turn, though, as had been expected, from Democrats to Republicans. And so a divided Congress does limit legislative work over the next couple of years and so less action on that front.

We can say a few other things of interest, though. And so one would be the Republican gains were actually a sign of weakness for the Republican Party. It’s normal in midterm elections for the opposition party to gain much more than that. So actually, it wasn’t much of an endorsement of the Republican Party.

We can say the Trump-supported wing of the Republican Party did particularly poorly. His supported candidates in many cases didn’t win. And so that would suggest his prospects for 2024 and the presidential election are somewhat diminished; he, by the way, having declared that he does plan to run in that election. And so those odds have diminished.

Seemed as though law and order as a theme was rising in importance. Some parts of the country that are normally Democrat went Republican, seemingly on concern about rising crime rates. And so that’s an issue that hasn’t been a dominant one for a while. It is coming back and that could be relevant again two years from now.

So what could happen over the next few years in terms of policy? And so one thought would just be the Democrats still have the Senate. They still get to make appointments as appropriate to the Supreme Court and to form committees and these sorts of things. The White House still gets to issue Executive Orders, though there are limits on that, as President Biden has found with his attempt to lower student loan debt that has been challenged in court and may ultimately not be legal.

There will be some common ground, we think. We think that both parties can get together to avoid debt ceilings and government shutdowns and those sorts of things. And so that’s an important thing to avoid. Both parties are anti-China. Both parties are anti-big tech firms. And so there is the possibility of action on those fronts. And lastly, if the U.S. economy does descend into recession, there will probably be some support offered by both parties, though maybe not to the standard of recent downturns because inflation is still much too high.

Okay. Let’s talk COVID for a moment. And so really the story here is one in which we continue to see the next generation of subvariants taking over. The BQ.1 and the BQ.1.1 subvariants are now about half of all new cases in the U.S. In contrast, the BA.5 subvariant, that’s been the dominant one for months now, that’s fallen from a 75% share of cases a month ago to just 25% today. So there is a new generation coming in. We can say that new generation almost definitionally is more contagious and, in particular, seems to be better at getting around vaccines, at least the existing generation of vaccines.

The good news, though, is that overall, infections globally aren’t really accelerating; they’re fairly steady. The same with hospitalizations; the same with fatalities. So it’s kind of an unusual situation. In a sense, there’s a new wave of variants; they aren’t, at this point, having a big effect on the overall numbers. And so that’s a happy thing.

The exception would be China, which has its zero-tolerance policy, but it also is suffering a big spike in infections that is now broadly on par with the spike that was suffered last spring. And so we’re seeing more lockdowns in China and we’re looking for a significant easing of Chinese rules perhaps next spring.

Turning to the economy. Well, mixed economic signals certainly the story. And so, for instance, Q4 GDP in the U.S. tracking quite a nice 4.2% annualized, so no real signs of trouble on that front. Retail sales were good in the latest release. Walmart says all is well at the corporate level.

But we are still seeing some signs of tentative weakness. Target, for instance, not saying all is well. Amazon sending warnings about a decline in shopping activity recently. And you can maybe tease out, how come Walmart says things are good and Target says they aren’t? Well, when people are shifting down-market toward cheaper products, that’s a situation in which Walmart would logically outperform Target. When people are pivoting from discretionary goods and continue to spend on groceries, which we think is happening, Walmart, fully half of its business is groceries. That’s not the case for Target. And so we think we are seeing some weakness in discretionary spending, as much as it’s being obscured at some of the largest retailers.

Tech sector is also maybe sending us some leading indicators. There have been widely reported large-scale layoffs among many of the largest tech companies out there. And so we think that’s partially an economic statement. These may indeed be a leading indicator and a lot of companies are cutting their advertising budgets. It’s an easy thing to cut. And so that’s happening and impacting many of the tech firms that are heavily reliant on advertising. Digital is maybe the easiest thing to cut within the marketing space.

But we do think there are also tech sector-specific issues that don’t say much about the economy. It’s clear the tech sector over-expanded previously. They thought the big growth during the pandemic would continue. And there’s been some reversal there as people have shifted back to brick-and-mortar establishments.

It’s also clear that online advertising has become less attractive and, therefore, less lucrative for tech companies because privacy rules have strengthened. It’s harder to track people across the internet. It’s harder to have a targeted ad. And so that’s really hurting the tech sector as well. And so we think there is an economic signal there, but it isn’t purely an economic signal.

Let’s talk recession signals for a moment. And so we look at a number of simple heuristics and two more just leapt into the yes recession department. And so those would be two more yield curve metrics have just inverted, which historically has presaged a recession. Of the 12 different recession signal metrics we now track, 7 are saying yes to recession; 2 are saying likely; 2 are saying maybe. In other words, the distinct majority are consistent with a recession at this point in time. And indeed, the consensus growth forecast out there does continue to fall for the majority of the world’s developed countries.

Okay. Let’s pivot into some special topics here. We’ll spend a moment on cryptocurrency. So to begin with, they are quite downtrodden. The prices are nowhere near where they were, for instance, a year ago. They have been shown maybe not to be the hedges against inflation or the oasis against financial market volatility that they were hoped to be. So some fundamental questions as to what just cryptocurrencies are, at least in an investment context.

We are now seeing some significant pain in terms of some of the businesses that work with cryptocurrencies. And so the Celsius crypto network declared bankruptcy in July. Now, one of the three biggest crypto exchanges in the world, FTX, appears to have failed with all sorts of allegations of misdeeds and potentially billions of dollars of client funds lost. It’s somewhat reminiscent of the failure of Canada’s largest crypto exchange in 2019.

And this is a significant blow to crypto. It’s not that the crypto itself failed in this case; it’s that the companies around them simply were not well regulated and were certainly not well run. We still think the most likely scenario in which cryptocurrencies play a bigger role in the world is central banks creating their own cryptocurrencies and giving a level of confidence to those assets. That has the best chance of becoming mainstream. And actually, China is pushing in particular aggressively forward on that front.

A quick word on the dollar. U.S. dollar has been very strong for the last year. It’s been a dominant theme. It has weakened significantly recently as inflation has come down, as risk inversion has ebbed a little bit.

I wouldn’t say we’re sure that this is the turn and that it continues from this exact point, but we do think there is room for a further decline in the dollar over the next year and beyond. It is fundamentally too strong. We do believe inflation can come down, which should hurt the dollar. We do think risk appetite can revive, which should hurt the dollar. So we think there’s room there and investors could well do better outside of the U.S. by virtue of the currency pickup they might enjoy.

Ukraine, the war in Ukraine, the war with Russia, Russian natural gas; I should say Europe has actually done a good job of building inventories. And so Europe is up to a 90% capacity in its natural gas storage facilities. That’s very good. It’s higher than Europe normally is going into the winter.

Let’s be aware. Europe will then draw down aggressively on that over the winter because Russia is not furnishing the normal supplies of natural gas. But it looks quite likely that Europe is fine this winter. It actually looks as though the European economy might not suffer quite as deep a recession as some had feared in 2023, though I would warn, shortages likely persist into the winter of 2024.

Let me finish with a word on COP27. And so this would be the latest annual meeting of global governments on climate change. And it was viewed as disappointing by many in terms of a lack of major commitments to advance in the fight against climate change. There was, for instance, a hope that there would be a promise to phase out all fossil fuels. Last year, there had been a commitment to phase out coal. The goal was to expand that. That didn’t happen, so that major goal was not achieved.

However, there was a framework built to compensate essentially poor countries for the damage of climate change, which really was wrought mostly by developed countries. About 60% of the world’s carbon dioxide emissions historically have come from the developed world. In fact, the U.S. is historically responsible for a quarter of all carbon dioxide emissions over the last few hundred years. And so the thinking is that these countries need to compensate the most adversely affected countries. At this point in time, there’s no amount of money assigned. There is no definition of who pays or who gets, and so it’s still very, very loose. But nevertheless, there is some work in that direction.

And I guess in general, really, one of the challenges of climate change is that you can say that developed countries have started to reduce their emissions, and so that’s a wonderful thing. Perhaps emerging market countries are the ones that need to now push quite hard.

But that’s not quite fair in the sense that developed countries still emit far more per capita than developing countries. For instance, the U.S. emits 15 tons of carbon dioxide per capita per year; China is just 7; India is less than 2. And so you could argue India and China should be allowed to continue increasing their emissions, but of course, that’s not a great solution to reducing climate change and reducing emissions.

And so I guess as it stands right now, it’s not a perfectly fair world, but it does seem as though all countries recognize they need to be pushing in this direction. And of course, that is hugely problematic for some sectors of the economy. It’s an opportunity for others. It’s a requirement to change for others still. But of course, not everything is about the economy. Nevertheless, a key, key theme here and one I think that’s going to be quite relevant and quite influential for markets and economies and countries, and perhaps fiscally as well, to the extent we start seeing bigger compensation funds form over the coming decades.

Okay. That’s it for me. I hope you found some of that useful and perhaps interesting as well. Thanks very much. Wish you well with your investing, and please consider tuning in again next time.