Blain’s Morning Porridge – Jan 17th 2023: Guest Post: Recession? Says Who?
“When the facts don’t fit, find other facts…!”
This morning: Delighted to hand this morning’s Porridge to my colleague Julian Wheeler, who reminds us not to fight the Fed, making the argument against deep recession and for stock market upside. Markets are about differing views and perspectives – and despite my latent bearishness, I find myself in agreement with much of what Julian says.
This morning I’m delighted to present for your early morning perusal a “guest” post from my most excellent colleague Julian Wheeler – our stock picker in chief specialising in the US market. Julian is yet another old market-dog, just like myself, with a healthy disrespect for received wisdom. When he gets the bone between his teeth with a strong market view he can be remorseless– as I discovered yesterday when he was all over me like the proverbial cheap suit when I showed insufficient bullishness on market prospects.
So, I asked him to write a counter to yesterday’s Bear/Neutral Morning Porridge. I hope you find it as thoughtful and entertaining as I did…
Recession? Says who?
Julian Wheeler; Shard Capital
A question being asked of investors right now is what matters more: Inflation or Recession? The answer is surely the latter if we accept that the CPI is now marching to the Grand Old Duke of York style – back down the hill – and starting to follow the line of Money Supply or a cunningly created and input weighted inflation model.
Bonds and Stocks have already priced in their current market assumptions – so a better question to ask is: ‘what will move markets up or down from here’? Leaving aside Ukraine or any other Black Swans (No-See-Ums as Bill calls them), the market’s first point of reference is the likelihood of a US / Global recession. Nothing genius about that until you ask “what factors are in place to cause a Recession?”
All I can come up with currently is the risk the Fed turns the screw too tight. Mizuho Securities economists said on Friday 13th: “Five of the last six Fed-tightening cycles have been followed by a quick policy reversal and a significant reduction in policy rates as the economy plunged into a credit crunch induced recession.”
Never forget how economists have forecast 9 of the last 3 recessions correctly.
Joking aside, this time is different. Central banks are Tightening from never-before-seen levels of Zero and Negative Interest Rate Policy (ZIRP and NIRP), highlighted by the peak absurdity when Bondholders were actually PAYING nations like Austria to look after their money! That was unparalleled. We reached that point based on a (genuinely) never-before-seen-events and are now retracing back from there, but so far only to a level of what would historically be considered “accommodating” policy. Now, just as Central Banks are getting a grip on this inflation they are going to ‘Pivot’ – the most mis- and overused expression – just because the market wants to go back to free money to boost markets?
That is what the future Fed Funds rate assumes. Market adage number 2: Don’t Fight the Fed. It makes as much fundamental sense as Buy Low / Sell High, but as many people don’t follow it as a fundamental principle either!
Are we all so smart and the Central Bankers so dumb? Nope.
Betting against Central Banks is betting against the House. Here are some other recent House Bets that weren’t clever to go against either; they are after all, the ultimate ‘Insiders’. The US Strategic Petroleum Reserve selling Oil between March and Sep, the Bank of Japan buying Yen in Sep/Oct and even the Old Lady got in on it, scooping up Gilts from panicky, over-leveraged Pension Funds. Apparently, the Bank of England has made a profit of £4bn from those purchases in the Autumn – nice one Bailey!
So, do we have a Credit Crunch looming?
- Financial conditions too tight – Nope.
- Credit and Insolvency Risk at companies in general – Nope (look at Credit Spreads)
- Unemployment levels suggesting recession – Nope (We’re at full employment!)
- Synchronised global GDP slowdown – Nope (because China is likely to improve from here and that might be the surprise to this year’s outcome)
- Stretched US consumer no longer able to spend – well, not yet, from what the 3 major US Banks said on their earnings calls last week. They noted some credit card issues, but how about the improving price of Energy which could offset this?
What have we heard in the last week?
- In the UK; Tesco, Sainsbury’s, M&S, JD Sports did well and while cautious did not give a gloomy outlook.
- German economy surprised on strong side – hooray for the weather; not good on the Alpine Pistes, but great for using less Natural Gas.
What did the US Banks have to tell us on Friday 13th? No horror story here.
- “The U.S. economy currently remains strong with consumers still spending excess cash and businesses [are] healthy,” JPMorgan CEO Jamie Dimon
- Bank of America’s consumer-deposit balances are showing “strong liquidity.” These balances are “drifting down,” CEO Brian Moynihan said on an earnings call, “but they still have plenty of cushion left.”
- “Our customers have remained resilient with deposit balances, consumer spending, and credit quality still stronger than pre-pandemic levels,” Wells Fargo CEO Charlie Scharf
These are not even close to Recessionary statements…..
And, what is happening in the markets?
- Dollar is weakening – Bullish
- Bonds are rising – Bullish
- Cyclicals and Small Caps are outperforming – Bullish
- Worst sector in S&P in January is Healthcare Insurance (Defensive) – Bullish
- Oil is lower – Bullish
- Covid is over in China – Bullish
- S&P is underperforming global markets – Bullish
The naysayers believe that there must be some payback for all that artificial (and in hindsight unnecessary) decade of monetary stimulus.
- What of Quantitative Tightening (QT) and the Treasuries the Fed needs to sell?
Despite the QT threat and the volume of bonds to sell, the 2yr T-Bill had its biggest one day rise after the last inflation number and the 10yr has gone from 4 ¼ to 3 ½ – showing there are happy buyers!
- Consensus says that profits must suffer through a recession for that to wash through. OK, but whose profits and what pays?
Remember SPACs / Crypto and all the absurd overvaluations given to everything from Peloton, Carvana, Argo Blockchain, ITM Power, and of course, Tesla? That’s where the payment has been made….90% in the case of the first three. But for the S&P as a whole? Earnings estimates are actually increasing at the moment (lower costs) and apart from overvaluation in the Mega Cap Monopolists, conditions remain normal-ish – given where interest rates had reached at their low.
Some of the largest US companies have been hit far harder than everything else. I may not like Facebook (how can you like an established branded company that changes its name and chucks its money away on a whim?) but it no longer looks expensive, and expectations are being ‘corrected’.
Housing is an issue – but not like it was back in 2008. The years of ‘free money’ have not been wasted by the canny US homeowner, who has refinanced themselves into really long term mortgages with rates of about 2%. Sure, turnover will slow, (you can’t port your mortgage over there) but they won’t be handing back the keys either.
When might there be a problem?
I was at the Scottish Mortgage Trust meeting on Friday and questions included “where do most opportunities lie at this point” and they suggested that new investments were likely to be very much in favour of PUBLIC markets over PRIVATE, where I sense that the valuation Piper has yet to be paid in full.
When is the market too high? When it gets excessive again.
- When you start to see stock issuance / IPOs again. There is far less equity around….so much has been bought back by the companies who issued cheap debt to fund it – harder to play that game any longer.
- All that money sitting in $ cash has to find its way back to the market and I doubt it will get flushed away on crypto crap this time.
- When these P/E firms who have been given waaayyy too much money start to try to unwind all this stuff onto (they hope) gullible public investors, just like in the record setting number of deals year of 2021.
- Money Manager surveys suggest sentiment is still very Bearish – that will change before the market goes down. They will be dragged kicking and screaming back to the market first as happens to all ‘Slaves to the Index’.
The balance of probability suggests it’s a 50/50 recession call. I would be surprised – which I why I think the market will continue to grind higher…..and why the Fed is TELLING YOU – yes, they are shouting – that they will NOT REDUCE RATES at least until next year.
It won’t be a straight line, perhaps a pullback over Q4 earnings season on profit taking first, but my call is that S&P goes to at least 4300 by July, but which is actually now less than 10% away after the move in the last two weeks. I think Consumer facing stocks, such as Delta Airlines and yes, Amazon will be doing best. I predict at least 30% upside for both, even after the 20% they have tacked on already since New Year’s Eve.
As Bill is my host here, it would be churlish not to close with his “favourite” stock (US readers: Sarcasm Alert)….Tesla. I have been in complete agreement with him about it being a Short/Sell/Avoid depending upon your investment style but….whisper it….I think the bottom is nigh!
You have to be of our vintage to remember ‘Marlboro Friday’ – April 1993 – when Philip Morris cut the price of ciggies by 20% to fend off and crush the generics. It reset their profitability (and share price) but they then went on a tear for about 5 years before Hilary Clinton tried to bankrupt them. Tesla has announced a similar strategy – cutting its EV prices dramatically last week – the cost of which will be revealed on Jan 25th . But after the inevitable earnings reset (of about 25%) that should be as bad as it gets. We will then have to see if the consumer is as addicted to a Tesla as a Marlboro Lite, but it might be a Buy at that point and certainly not a great Sell.
Julian Wheeler – Shard Capital
Bill Blain writes:
Thanks Julian – very well made case.
Julian’s analysis is not so far from my own thoughts. It initially fits my own outlook although I see risk of a recession as slightly higher. I expect markets are likely to range trade – but certainly with opportunities to pick individual stocks rather than the indices – before we see cost of living/consumption crisis really bite in term of consumer and corporate debt, plus earnings under pressure, later this year. My worry is stubborn inflation and rates remaining higher for longer.
Longer term I fear this could still deepen into a global recession, triggering a fundamental unwind of financial asset inflation since 2009, with a significant equity mean reversion becoming a potential threat.
As always, we’ll be commenting on it here at the Morning Porridge!
Five Things To Read This Morning
Out of time, and Julian and I are both off back to the day job
Strategist, Shard Capital