13 May Boom Times Ahead!
“Is the bull back?” – The Lonely Realist
The bear warnings have been ominous. Virtually every seasoned analyst today is predicting a 2023 recession. One of America’s premier economists, A. Gary Shilling, goes further, saying that the recession already has started …, although it “won’t be ‘officially’ declared for months or even quarters.” He interprets “most leading indicators as heralding an economic decline,” and cites a litany of cumulative negatives: “The first phase of the weakness in the economy and drop in stocks was due to Fed credit-tightening. The second leg results from falling economic activity as well as declining corporate sales and profits. Central banks and other government agencies here and abroad are containing the run on banks, but as they tighten bank regulations and scared banks hype lending standards while depositors flee, credit availability will shrink, to the detriment of the economy. Labor markets are easing as real pay falls. Commercial real estate, especially office buildings, is joining housing in the tank as vacancies and financing costs leap. Businesses and cities that depend on office worker spending and property taxes are suffering. Except for energy, which seems problematic, stocks across the board have fallen in this bear market, including defensive stocks such as utilities, consumer staples and health care. The bear market will persist….”
The markets have rejected that analysis. They’ve been foretelling the opposite story, moving higher with an intensity historically experienced only after a stock market bottom. The NASDAQ this past week edged past the bull market threshold, rising >20% from its 2022 low. The S&P and Dow are similarly higher. Inflation is waning (a steady decline that continued this week) and unemployment is at an historical low of 3.4%. The Gloom-and-Doomers nevertheless have been forecasting another leg down in the markets …, which is what they’ve been predicting for these past 6 months. They’ve been wrong, wrong even though their forecasted downdraft should have been accelerated by the collapse of the regional banking industry. With the bearish consensus so focused and so negative, and with history showing that fighting either the Fed or the markets is a profitless endeavor, a contrarian would see today’s pessimism as a bullish signal. Might the world indeed be headed towards boom times?
The markets are true believers in the perspicacity of the Federal Reserve, America’s trusted economic pilot, and they’re comfortable that, even after a spate of inflationary turbulence, the Fed will be able to bring America’s economy in for a soft landing. They have priced in a pause in the Fed’s hiking cycle followed by a series of interest rate cuts. The question is whether that will prove to be correct. Will the Fed, without any assistance from the Federal government, have sufficient navigational skill to successfully steer the American economy? Talking heads on TV believe so, concluding that it will continue to perform as it did through the dozen+ difficult years that followed the Great Recession, timely deploying interest rate eases and hikes, QE and QT. They see the recent Fed interest rate increases as having worked extraordinarily well, modestly expanding unemployment while reducing what now appears to have been transitory, COVID-linked supply-chain inflation. It’s been mission accomplished! They anticipate that inflationary pressures will continue to wane on the way back to 2%, or perhaps even 3%. If so, the Fed’s hiking cycle will have ended and will be followed by interest rate reductions of 1% this year and 1.2% in 2024, both of which have been priced into market valuations. This bullish thesis equates lower interest rates with enhanced economic growth and higher stock prices, the best of both worlds – rate cuts combined with durable growth. There may be some bumps in the road, but there is conviction that the Fed will do whatever it takes to ensure a smooth economic landing and, most importantly, that it has both the tools and the ability to do so. Unfortunately, fine-tuning economies is not that simple.
Economics is called the dismal science for good reason. It isn’t a hard science like physics with immutable rules. Forecasting the economic future is largely an exercise in guesswork. The global economy has an almost infinite number of components that are constantly changing, generating a quantity of data than is incapable of being processed and integrated. Further, today’s backdrop for forecasting the economic future is an unprecedented 3+-year pandemic that propelled debt, deficits and spending to levels never before seen.
In retrospect, the Fed’s fast-paced 5% hike in interest rates over the last 13 months generated relatively benign results that fueled economic growth and higher stock prices. However, those rate increases also created strains, the most noticeable of which to-date has been the gushing red ink in regional banks’ balance sheets. Additional cracks in the economic firmament may radiate from both that red ink and the broad secular cyclical changes that continue to ripple through the economy. These include de-globalization and onshoring, widening income inequality, technological breakthroughs, the rapid progress in AI that only now is beginning to disrupt labor markets, and demographic change. What if some combination of stresses and events should cause inflation to ratchet up? If so, the Fed has shown a proclivity to address problems by printing money, more and more money. That would be inflationary. With Congress having provided only empty promises of fiscal probity, Americans have been voicing enthusiasm for more government spending. That’s inflationary. The printing of money and central government spending are not a recipe for stability. Moreover, the global rejection of carbon-based energy will continue to pressure the prices of everything. Might concern over inflationary kindling lead the Fed to continue with a cautious anti-inflation approach rather than execute the rapid reduction in interest rates anticipated by the markets? And what of exogenous events and political headwinds such as the debt ceiling debacle debate? If inflation does not continue coming down, interest rates will have to increase. If inflation is coming down as the markets believe, interest rates will as well. Neither outcome is clear. In short, predicting the economic future is a soothsayer’s task fraught with risk …, as readers may recall from Cassandra’s warnings earlier this year. Boom times ahead? Fingers are crossed.
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Finally (from a good friend)