Hanke measures - Inflation is everywhere

The developed world is currently crazy about inflation but take a close look at some of the emerging and frontier market inflation numbers. Inflation is out of control as measured by free-market exchange rates from the Steve Hanke's website, Hanke's Inflation Satellite. 

Showing these numbers does not diminish the problem in the US or other DM markets, but it does show that prices can get out of control if there are not strong institutions and governments that have the desire to control inflation excesses.

China global financial stress elevated but not unusual

Implicit monetary policy is tied to financial stress along with growth and inflation. While it is not generally discussed in the central bank reaction function, there is a greater focus on macro-prudential policy and measurement. A good macro measure is to use some financial stress indicator index. These stress indicators will be correlated because stress is often global through a world-wide economic growth or financial market shock. 

China financial stress is elevated on a relative and absolute basis; however, it is still contained relative to the past and versus other countries as measured through a NYFED model. Generally, EM stress will be greater than in developed markets. 

The NYFED stress model includes equity returns, financial sector returns, equity volatility, short-term rates, the yield curve shape, interbank spreads, corporate bond spreads, sovereign bond spreads, and US bond convenience yields. It tracks closely with the Chicago Fed, KC Fed, ECB, and Bloomberg stress indices. 

Clearly, junk bond spreads have exploded in China and volatility has increased, but the combined stress measure is nowhere near March 2020 pandemic levels. Nevertheless, given the size of the China market, stress measures should be tracked closely to determine portfolio risk allocations.

Rates versus absolute change - Mistakes that investors make that matter

Behavioral biases exist and they really do matter for both the individual investor and markets overall. A provocative paper attacks one of the more obvious problem in finance that should have been explored much earlier. The paper, "Can the Market Multiply and Divide? Non-proportional Thinking in Financial Markets" studies the problem that investors don't seem to understand the difference between a $10 price change and 10% or proportional change. 

We may be so used to hearing financial data presented in a certain way that we don't even notice the problem. A commentator will say stock x is up $5, or the benchmark index is up Y points without saying the percentage change is contributing to the bias. 

This problem becomes obvious when you scale values by price, a $x change in a stock that has a low price will have a very different meaning from a $x change in a higher priced stock. Proportionality matters. Ineffective juggling between dollar price and percentage changes is a problem for the individual, but when explored at the market level it can explain some of the odd anomalies or puzzles seen in the stock market. 

Investors usually think about dollar not percentage units which leads to more extreme responses to news for lower priced stocks. Higher price stocks will be less volatile - a doubling in price will lead to an approximate 25% decline in volatility. Consequently, volatility jumps after a stock split. Lower price stocks will respond more strongly to firm-specific news. This non-proportional thinking can explain size-volatility/beta relationships, the leverage effect and return drift.

Guard your thinking through always thinking about the proportional impact of prices. 

The "extreme precariousness of the basis of knowledge"

"The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analyzed it carefully.... Our conclusions must mainly depend upon the actual observation of markets and business psychology.... The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made. Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible." 

- Chapter 12 "The State of Long-Term Expectation" from The General Theory of Employment, Interest and Money"  John Maynard Keynes 

I like the term "precariousness of the basis of knowledge". I had to help with a private company valuation in a fast-changing industry. The difference in valuation given some simple assumptions was enormous, and I was using some very standard valuation techniques. 

The same uncertainty problem applies to any forward estimate of rates, inflation, or the dollar. Perhaps we can speak to trend or views in the short run, but the range of potential estimates out to a year or more is so wide to be almost useless. Our only savior is the range of past behavior over a year horizon, but in a highly uncertain macro environment that conditional restriction may also work against an effective forecast.