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recession? What recession?

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There is now increasing talk about a ” No landing” scenario among “analysts”. Are we really getting away with this so easily? I say: not so fast!

The S&P and Nasdaq indexes have reached new recent peaks: some 20% above the low put in on Oct-2022. Indeed there is even a new (albeit shallow) up-trend line established for the second time since 2020. At the same time, this blog’s predicted oscillatory (aka side-ways) price action in the broad indexes has also held true since early 2022. This is especially more clear when we realize that the recent rise in the indexes have been on the back of a mere 8 symbols. We re-iterate sideways action will persist (albeit with sometimes wide gyrations) for a long time to come.

Attributing the rise in the indexes to the rise on only 8 stocks, it becomes easier to see why the indexes have defied the strong pull of the bonds hanging beneath them. Those 8 companies are sitting so much cash (in part due to misguided helicopter-money policies during 2020/21) that they are disconnected from the cost of borrowing. The rest of the market is simply not able to compete.

There will be a reckoning as the real effects of

1. draining of consumer-cash accumulated during 2020/21, and

2. Delayed impact of the much higher rates hits the business end of life by very late 2023 and into 2024.

The first factor is illustrated below in a report on the FRB-SF:

The authors state: Cumulative draw-downs reached $1.6 trillion as of March 2023 (red area), implying there is approximately $500 billion of excess savings remaining in the aggregate economy. Should the recent pace of draw-downs persist—for example, at average rates from the past 3, 6, or 12 months—aggregate excess savings would likely continue to support household spending at least into the fourth quarter of 2023. This outlook can be possibly extended into 2024 and beyond if, for instance, draw-down rates moderate or household preferences for savings increase.

The second factor is more pernicious. A bit like a sneaker wave, it will give much less warning than the first factor. The folks at Morgan-Stanely have a “model” for short term forecasting of the broad average of company earnings using the data from the Federal reserve’s “survey of senior loan officers”. You can see the results of their model and read their interpretations of their model here:

Below we show the core data used in their model:

In essence, there is a very strong correlation between the of the sentiment of the loan officers in lending to large businesses and the Earnings of the said businesses. In addition, the sentiment seems to lead the EPS by a good five to six months. The above graph shows the sentiment shifted forward by six months and super-posed on the S&P500 EPS. If the correlation is to hold, the EPS is expected to fall along the path of the red arrow. With a an already bloated S&P P/E, a falling E is not going to help. Indeed, many bulls are hiding their heads in the sand in nearly plain sight of it.

Based on much stronger tidal forces, we still maintain a forecast of oscillatory movement in the US stocks. The recent run in the S&P will soon cease and downward pressure into 23Q3 will build. Thereafter, as Morgan-Stanley divines: (following the EPS drop) the Fed’s policy will become more accommodative for growth, but that will come with interest rate cuts in 2024, not late 2023 as futures markets currently indicate. We agree, at least with the conclusion that there will major pressure to cut: will they? can they?.

Things only begin to get interesting then! How is that?

The larger demographic tidal forces will create an environment where the Fed (nor indeed any modern economy) has ever had to deal with. First with the baby-boomers retiring, they will take their cheap capital with them forcing the cost of capital (interest rates) permanently raised for at least the next ten years. Second, due to the smaller supply of workers (esp. educated work force as boomers retire their jobs) the wage inflation will keep general inflation high. Given that the US government ca only operate on a large deficit it will require the Fed to lower rates ASAP! And that will be a tall order in the face of persistent (wage) inflation

Robots (and “AI”) to the rescue? We’ll see.

In the short term, we have tuck as much as we have liquidated from stocks in T-bills. As of this writing, the 2023-Nov-30th T-bill yields upward of 5.35% . Further, if you live in a high income-tax state, then the effective rate is even higher. For example in California, the effective T-bill return is a whopping (5.35% x 1.133 )~6%/yr.

We’ve previously covered other viable investments for this environment. To reiterate one: The dwindling supply, (due to lack of investment in exploration) and missing spare capacity of crude production, large oil companies and financially-healthy, dividend-payer oil services and explorer are good defensive investments. Longer term, Gold, Copper, and Uranium miners are to be looked at.