No Recession But a Weak Stock Market

The stock market is trading like the economy is about to enter a big growth slowdown, and possibly even a recession.  I am hearing lots of talk about the Fed breaking something and having a hard landing.  This reeks of myopic market focused thinking, with total disregard for the real economy, and the absurd fiscal policy that's still pumping huge amounts of money into the economy in the background.  

It was fashionable to talk about the massive Covid fiscal stimulus and QE double bazooka in 2021 as the markets kept going higher.  Now its fashionable to talk about a hard landing as the Fed does 50 bp hikes and QT in the coming months.  While monetary policy is definitely going to be much tighter, there is still $1.7 trillion of excess liquidity looking for a home that is stuck collecting 25-50 bps in the Fed repo facility designed to sop up all the QE created excess liquidity.  There is no shortage of liquidity in these markets.  QT will keep bond yields higher than if there was no balance sheet reduction, but I'm betting that Yellen will be financing a big portion of the deficit with T-bills, not coupon bonds.  That will have a less negative effect on Treasuries than if coupon bond issuance was expanded. 

I still believe we're entering a bear market, but not because the Fed will break something and cause a recession, its just because investors got way too exuberant and overweight equities over the last 18 months.  It will be a lot more like 2000 to 2002 than 2007 to 2009.  I don't even think that the US economy will get as weak as it did during the post dotcom bubble economy of 2001 and 2002.  Back then, there were even budget surpluses, and the budget deficits were a tiny percentage of GDP, around 1-2%.  Now its at 6.4% of 2022 GDP, and that after 13% of GDP in 2021.  We are in a totally different planet when it comes to the fiscal pumping of the economy.  That will keep inflation higher than normal and disappoint those looking for a crash landing and a recession.  

 

Now the economy in Europe and Asia are a different story, but those stock markets are already reflecting a much weaker economy, more so than US stocks are.  There is no valuation froth in Europe and Asia, so its not priced for perfection like US stocks were before this recent swoon.  So even though I expect the US economy to outperform expectations vs Europe/Asia, the US stock market likely underperforms because of the big overweight investors have in the US.  

There will be some wealth effect related weakness in the economy this year, and that will counteract some of the positive growth effects from the government spending, but overall, growth probably goes back to the mediocre 2012-2019 level, which is enough to keep the commodities bull market going and keep the stock market from a total crash scenario, as some are forecasting.  

The price action this week seems to confirm the gut feel that market is bottoming and found another bottom at similar levels made in March at 4170-4180 SPX.  This should take the market higher over the next 3 weeks as the big earnings reports are now behind us, and FOMC meeting of 50 bps and QT announcement will likely be sell the rumor, buy the fact in my view.  Not sure how far we bounce up to in the coming weeks, anywhere from 4500 to 4600.  By early June, I expect the market to have either already topped out or be very close to a local top, so a short opportunity will be there.  That will be the time to put on short positions to ride lower during the summer.  

Don't lose track of the big picture:  lots of fiscal pump and small reversal of monetary pump.  That is the mirror image of what was happening from 2010 to 2017, before the Trump tax cuts and Covid pork stimmy fest.  We know what happens when there is a lack of fiscal stimulus and a lot of monetary stimulus:  a strong bond and equity bull market, but a low growth economy.  How about when we get a lot of fiscal stimulus and a lack of monetary stimulus, like what we will see over the next several months?  Probably a weak bond market and stock market, but a surprisingly strong economy.  Basically a great backdrop for commodities.