As we write, the U.S. stock market is undoing the momentary relief that followed yesterday’s hawkish Fed announcement. The proximate cause was perhaps the overnight announcement that the Swiss National Bank would consider selling down its $177 billion worth of U.S. equity holdings as it defends the Swiss franc. Perhaps that sale implies a belief that these assets are among the least desirable in its portfolio at the present juncture, for whatever strategic or tactical reason.
The market’s dismal behavior may also reflect that the likelihood of an oncoming recession (if indeed it is not already here, as the Atlanta Fed’s “GDP Now” suggests) is really sinking in. While Mr Powell spoke mostly in positive terms about the economic outlook yesterday, we beg to differ, as we see plenty of indicators of damage already done by rising rates, and not just to stock valuations. Negative economic surprises have risen dramatically this year. The Conference Board’s survey of “CEO Optimism” has declined to a level that historically has always been associated with an “earnings recession.” The “Misery Index” — a measure that combines inflation and unemployment — is at the same level it was when Mr Biden was last in the White House, back in 2011. Layoffs are rising, albeit thus far largely constrained to the tech companies who led the pandemic bull market and are now leading the rout.
Also as we write, the extreme relative strength of the dollar may be showing cracks, as other global central banks join the Fed in raising rates. In the 1970s, gold rose strongly in an inflationary environment; it has thus far not performed as expected, in large part because of relative dollar strength. Should that strength fade, that could be the impetus for gold to behave more in line with its historical relationship with high inflation.
The market’s dismal behavior may also reflect that the likelihood of an oncoming recession (if indeed it is not already here, as the Atlanta Fed’s “GDP Now” suggests) is really sinking in. While Mr Powell spoke mostly in positive terms about the economic outlook yesterday, we beg to differ, as we see plenty of indicators of damage already done by rising rates, and not just to stock valuations. Negative economic surprises have risen dramatically this year. The Conference Board’s survey of “CEO Optimism” has declined to a level that historically has always been associated with an “earnings recession.” The “Misery Index” — a measure that combines inflation and unemployment — is at the same level it was when Mr Biden was last in the White House, back in 2011. Layoffs are rising, albeit thus far largely constrained to the tech companies who led the pandemic bull market and are now leading the rout.
As we noted last week, if the U.S.. is not already in a recession, we believe that it will be soon. And this is not a negative for investors — at least, not for those who can make the strategic adaptations that we noted in our main piece this week. On the contrary, the market will find a bottom before the economy does — a lot of damage has already been done, and by applying the tools in our “bear market playbook,” investors can already begin identifying bargains that Mr Market is marking down to irrational levels. (Not that those levels cannot go lower — but as we noted last week, this is the time to start getting interested, as others are moving towards despair.)
For our clients, we hold considerable cash balances which we will be able to deploy opportunistically to take advantage of the opportunities and bargains that lie ahead – as well as holding commodity and real-asset linked investments, and individual stocks which we believe are well-positioned for the current and emerging environment. We do not own bonds, and we do not own illiquid alternatives.
It’s important to remember as well that whatever price-to-earnings multiple the market assigns to stocks, it is assigned to nominal earnings. Though an economic recession and an “earnings recession” go hand-in-hand, inflation will boost nominal earnings. That is yet another reason not to discount stocks as inflation defense; this is a role they have served in countless inflation episodes in many global economies. It is important to remember that nominal GDP growth was 12% last year, and will likely be 8–10% in 2022.
Thanks for listening; we welcome your calls and questions. We’ll be hosting a Zoom call on June 30 — keep an eye out for the link, and please send us your questions ahead of time.
