Here we are less than 2 days after I published this article and I have already altered my view from what is written above, but only slightly. This why you need to develop your own view on the economy & markets rather than relying on others to form it for you. Unless you are paying someone else for the privilege, portfolio managers & other market professionals (like myself) can change their view in an instant and they are under no obligation to update you on their changed outlook. This is what I was taught in my earliest days in the market - you've got to have a view.
So, what's changed? Just like I said in the article, that stimmy & QE could prolong the time until the coming downturn, the current tightening cycle caused by the spike in CPI can hasten the downturn. How so? A Fed induced tightening cycle via raising interest rates takes time to fully impact the economy because most households & companies have fixed rate loans. So, only when the current fixed rate period expires will loans be reset at the now higher interest rates. By comparison, only businesses (and not all of them) have fixed cost supply contracts. As such, a CPI induced tightening cycle will hit the economy much faster because all households and many businesses will be hit with higher costs immediately.
Because of this difference, it is possible that a double dip recession and/or significant market fall could happen sooner than the 2023 estimate posted above. This could especially be the case if stimmy stops and QE is tapered etc. Be warned thought, I have been guilty of being early in my timing of calling a recession etc. in the past. For example, I called for one in H2 of 2019 only for it to happen in H1 2020.
Excellent article ty!... would appreciate your perspective on the following: with the slowing economy, it's unlikely that QE will be tapered - as you said rising CPI will only hasten the overall downturn... the good - it will help to reduce the US debt / debasing the currency is the way to go. The question is what else does the bond market sees? A) CPI impact and slow down B) treasury inability/need to increase debt levels C) housing - 1.8 homes will lose subsidies / and a % will not be able to meet the next house payment D) smaller employment pool - people taking retirement earlier - smaller working-class shrinking GDP... market is expecting slowdown and reduction in earnings...?
(A) In relation to views on CPI, the bond market is forward looking. Inflation is the primary risk to fixed income investments, which is why bond yields began rising mid-2020 and are falling now. The high inflation numbers are now in the past (all reported data is by definition historical). Therefore, today's bond yield is pricing in future inflation expectations and over a wide period of time (i.e. a long-term average), which is much lower than last quarter's CPI. The same goes for expectations on growth.
(B) Government debt will continue to rise to compensate for a slowing economy. I'm not sure it's the right thing, but they'll do it anyway. I expect U.S. debt as a percent of GDP to double over the coming decade, just like Japan & Europe.
(C) Homelessness will increase. It's a problem already, but the gap between haves & have-nots will widen and social unrest will likely grow. But home ownership will become increasingly expensive also. The slowing economy will put increasing costs on governments (state & federal), especially with all their unfunded pension liabilities and a population bubble now entering retirement. State taxes & debt will increase to cover costs, and states get this mostly via property taxes - rents may rise further, which will exacerbate the problem - a negative spiral, but one that may eventually lead to property values dropping (a-la some forgotten places in Europe, where you can now by houses in empty towns for $1). In the meantime, it will likely result in population movements to warmer & lower-tax states. I expect that a number of U.S. states will become insolvent - not unlike the Eurozone's sovereign debt crisis, where certain weak nations impacted the debt of every nation in Europe.
(D) I touch on this in a couple of my latest posts. The smaller working age population is a function of the Baby Boomer generation now leaving the workforce and entering retirement. The powers that be thought that this one-off historical demographic anomaly (i.e. the post-war baby boom) was a new normal and established policies based on this erroneous assumption that it would continue. Instead of saving/investing during this time of windfall gains they have burdened themselves with unproductive debt trying to maintain growth at this level (this is true for households, corporations & governments). Simply due to the fact that an abnormally large proportion of the population is now no longer working and producing income but will start drawing on the economy (via pensions, many of which are not fully funded) is enough to drastically reduce economic growth & earnings/revenues. The burden will fall on a smaller proportion of the population (like a ponzi scheme). The coming decade is not looking good from any angle. Again, it will be much like Japan & Europe where the economy has been stagnant. Both regions have also experienced significant asset price resets (e.g. housing) and negative interest rates. People have to adjust to living much less extravagant lifestyles - a return to simplicity, which can be a hard/traumatic adjustment.
Thank you / sorry for the delay in response. Ty for the long term perspective / was Loki g more at the short term potential correction in the market. On one side we could see the 2000s scenario and slow market deleveraging / on another we keep printing so much money it’s not clear where it is headed.
LOL, my bad. One of the first things you learn in markets is to ascertain the timeframe of another person's view to understand whether they are thinking in terms of days, weeks or months etc. I should've clarified with you.
I am anticipating the market to turn from mid-2022ish, which would be confirmed if we start to see volatility increasing (i.e. larger intra-month ranges) over coming months (volatility typically increases at market turns - most notably at market bottoms). I also expect the turn to be slower in nature, i.e. not the large & fast variety like March 2020. I say this because there is a large amount of tail-risk protection (although delta hedging by option sellers can exacerbate things), but also because the market requires that collective disbelief that this is the beginning of a turn - i.e. "it's just a correction" or "I'll sell once it comes back up" etc. only to miss selling at each lower high on subsequent rallies. This behavior is why major turns start slow and accelerate into their endings. I don't think the market is quite at that stage yet.
The Fed sound like they are close to the point of reducing their QE & I think they are being fooled by the headline strength in the Employment data (as per my other posts on this website). If they do start tapering, it could be the catalyst that begins the turn. Additionally, the market is so conditioned to Fed QE underwriting stocks that this could also be a reason why the market will be slow to react to the turn. It will come as a real shock to many market participants when sentiment turns & even QE won't be able to stop things, but the Fed will try very hard by printing frantically.
At present, the bond market is telling me that things are not looking strong economically, because the yield curve seems to be flattening again (as per my recent tweet here: https://twitter.com/morphoadvisory/status/1440074549702246401?s=20). I fully expect the yield curve to invert again - using the method I developed rather than the traditional 10y-2y spread. I don't think the 10y-2y spread will invert before the next recession & will therefore shock people by not signaling a recession.
But all major market turns require a catalyst and, as you say, it is not clear at this stage what that will be. We know the underlying economic structure is weak, but we await that Lehman moment that people will look back upon to use as their rationale to explain why things turned. In reality the entire economic & market structure is being held up by excessive debt due to low interest rates. Anything that inhibits continued borrowing could be the cause or perhaps consumption falls so corporate revenues drop? Perhaps a large/high profile corporation fails?
Here we are less than 2 days after I published this article and I have already altered my view from what is written above, but only slightly. This why you need to develop your own view on the economy & markets rather than relying on others to form it for you. Unless you are paying someone else for the privilege, portfolio managers & other market professionals (like myself) can change their view in an instant and they are under no obligation to update you on their changed outlook. This is what I was taught in my earliest days in the market - you've got to have a view.
So, what's changed? Just like I said in the article, that stimmy & QE could prolong the time until the coming downturn, the current tightening cycle caused by the spike in CPI can hasten the downturn. How so? A Fed induced tightening cycle via raising interest rates takes time to fully impact the economy because most households & companies have fixed rate loans. So, only when the current fixed rate period expires will loans be reset at the now higher interest rates. By comparison, only businesses (and not all of them) have fixed cost supply contracts. As such, a CPI induced tightening cycle will hit the economy much faster because all households and many businesses will be hit with higher costs immediately.
Because of this difference, it is possible that a double dip recession and/or significant market fall could happen sooner than the 2023 estimate posted above. This could especially be the case if stimmy stops and QE is tapered etc. Be warned thought, I have been guilty of being early in my timing of calling a recession etc. in the past. For example, I called for one in H2 of 2019 only for it to happen in H1 2020.
Excellent article ty!... would appreciate your perspective on the following: with the slowing economy, it's unlikely that QE will be tapered - as you said rising CPI will only hasten the overall downturn... the good - it will help to reduce the US debt / debasing the currency is the way to go. The question is what else does the bond market sees? A) CPI impact and slow down B) treasury inability/need to increase debt levels C) housing - 1.8 homes will lose subsidies / and a % will not be able to meet the next house payment D) smaller employment pool - people taking retirement earlier - smaller working-class shrinking GDP... market is expecting slowdown and reduction in earnings...?
Thanks, BowTiedStich.
(A) In relation to views on CPI, the bond market is forward looking. Inflation is the primary risk to fixed income investments, which is why bond yields began rising mid-2020 and are falling now. The high inflation numbers are now in the past (all reported data is by definition historical). Therefore, today's bond yield is pricing in future inflation expectations and over a wide period of time (i.e. a long-term average), which is much lower than last quarter's CPI. The same goes for expectations on growth.
(B) Government debt will continue to rise to compensate for a slowing economy. I'm not sure it's the right thing, but they'll do it anyway. I expect U.S. debt as a percent of GDP to double over the coming decade, just like Japan & Europe.
(C) Homelessness will increase. It's a problem already, but the gap between haves & have-nots will widen and social unrest will likely grow. But home ownership will become increasingly expensive also. The slowing economy will put increasing costs on governments (state & federal), especially with all their unfunded pension liabilities and a population bubble now entering retirement. State taxes & debt will increase to cover costs, and states get this mostly via property taxes - rents may rise further, which will exacerbate the problem - a negative spiral, but one that may eventually lead to property values dropping (a-la some forgotten places in Europe, where you can now by houses in empty towns for $1). In the meantime, it will likely result in population movements to warmer & lower-tax states. I expect that a number of U.S. states will become insolvent - not unlike the Eurozone's sovereign debt crisis, where certain weak nations impacted the debt of every nation in Europe.
(D) I touch on this in a couple of my latest posts. The smaller working age population is a function of the Baby Boomer generation now leaving the workforce and entering retirement. The powers that be thought that this one-off historical demographic anomaly (i.e. the post-war baby boom) was a new normal and established policies based on this erroneous assumption that it would continue. Instead of saving/investing during this time of windfall gains they have burdened themselves with unproductive debt trying to maintain growth at this level (this is true for households, corporations & governments). Simply due to the fact that an abnormally large proportion of the population is now no longer working and producing income but will start drawing on the economy (via pensions, many of which are not fully funded) is enough to drastically reduce economic growth & earnings/revenues. The burden will fall on a smaller proportion of the population (like a ponzi scheme). The coming decade is not looking good from any angle. Again, it will be much like Japan & Europe where the economy has been stagnant. Both regions have also experienced significant asset price resets (e.g. housing) and negative interest rates. People have to adjust to living much less extravagant lifestyles - a return to simplicity, which can be a hard/traumatic adjustment.
Thank you / sorry for the delay in response. Ty for the long term perspective / was Loki g more at the short term potential correction in the market. On one side we could see the 2000s scenario and slow market deleveraging / on another we keep printing so much money it’s not clear where it is headed.
LOL, my bad. One of the first things you learn in markets is to ascertain the timeframe of another person's view to understand whether they are thinking in terms of days, weeks or months etc. I should've clarified with you.
I am anticipating the market to turn from mid-2022ish, which would be confirmed if we start to see volatility increasing (i.e. larger intra-month ranges) over coming months (volatility typically increases at market turns - most notably at market bottoms). I also expect the turn to be slower in nature, i.e. not the large & fast variety like March 2020. I say this because there is a large amount of tail-risk protection (although delta hedging by option sellers can exacerbate things), but also because the market requires that collective disbelief that this is the beginning of a turn - i.e. "it's just a correction" or "I'll sell once it comes back up" etc. only to miss selling at each lower high on subsequent rallies. This behavior is why major turns start slow and accelerate into their endings. I don't think the market is quite at that stage yet.
The Fed sound like they are close to the point of reducing their QE & I think they are being fooled by the headline strength in the Employment data (as per my other posts on this website). If they do start tapering, it could be the catalyst that begins the turn. Additionally, the market is so conditioned to Fed QE underwriting stocks that this could also be a reason why the market will be slow to react to the turn. It will come as a real shock to many market participants when sentiment turns & even QE won't be able to stop things, but the Fed will try very hard by printing frantically.
At present, the bond market is telling me that things are not looking strong economically, because the yield curve seems to be flattening again (as per my recent tweet here: https://twitter.com/morphoadvisory/status/1440074549702246401?s=20). I fully expect the yield curve to invert again - using the method I developed rather than the traditional 10y-2y spread. I don't think the 10y-2y spread will invert before the next recession & will therefore shock people by not signaling a recession.
But all major market turns require a catalyst and, as you say, it is not clear at this stage what that will be. We know the underlying economic structure is weak, but we await that Lehman moment that people will look back upon to use as their rationale to explain why things turned. In reality the entire economic & market structure is being held up by excessive debt due to low interest rates. Anything that inhibits continued borrowing could be the cause or perhaps consumption falls so corporate revenues drop? Perhaps a large/high profile corporation fails?