From Eagle to Pigeon

The United States economy is just not dynamic anymore.  The United States used to be a manufacturing powerhouse, and was subject to the whims of the capitalist boom and bust cycles.  It used to be like an eagle soaring high and swooping low.  Now its more of a pigeon that just walks around, with short bursts flying higher, and then back to the ground, where it lingers.  The amplitude of the ups and downs of the business cycle has gone down.  But the average height has also gone down.  The highs are lower, and artificial, a result of massive fiscal stimulus, while the lows are less dramatic, also because of massive fiscal stimulus.  Its not as bad as Europe, where the government is such a huge part of the economy that the business cycle has essentially turned into a flat line, at a very low level. 

One of the benefits that you get with an aging population and more services and less manufacturing is a less cyclical economy.  Old people don't spend much money on stuff, other than food and fuel.  It spends a lot of money on services, such as health care, hospitality, and restaurants.  Old people keep getting government money for nothing, and keep spending it on services.  Services for doing nothing.   And that story is being repeated millions of times (more millions each year as baby boomers retire).  That's inflationary.  But it also helps to keep the economy out of recession. 

The old boom bust cycle was based on manufacturing being a big portion of the US economy.  Now, manufacturing is minor, almost an afterthought.  Offshoring has dramatically changed the US.  Sure, you hear talks about re-shoring, but much of that is government subsidized and not "natural".  The US is not cost competitive with Asia when it comes to most manufacturing.  Labor costs are just too high.  In the past, when you had a manufacturing heavy economy, the cycle of overbuilding, overcapacity, overproduction, and big inventory builds would make an economy vulnerable to a recession.  Sure, rate hikes sped up the process of tipping over a vulnerable economy, but the underlying forces of the economy were very cyclical.  You had almost exclusively variable rate mortgages.  More variable rate bank loans rather than long term fixed rate bond issuance. 

Now, you have an economy that's mostly services.  Manufacturing, construction, and transportation/warehousing are less than 20% of the US share of GDP.  With such a small share of GDP in those cyclical sectors, there needs to be big down moves in those areas to drive the economy into a recession.  That's unlikely when you didn't have the overinvestment and overconstruction in the first place. 

The US economy is now a less cyclical, lower growth economy.  The biggest source of growth in the US is the government.  Government spending is the growth driver of the US.  Its not AI.  Its not data centers or high tech.  Its pork.  That's the sad state of what was once a very dynamic economy that had lots of competition and much more laissez faire markets.  Now you have an economy that's become more rent-seeking, more financialized, with less innovation and lower productivity.  Corporations have formed oligopolies, which requires less investment spending, and more spending on lobbying and regulatory capture.  

The foundation of America is slowly rotting and government spending is like the paint job covering all the mold and mildew underneath.  Killing the business cycle is not a good thing.  Economists like to think of recessions as being negative, and booms as being positive.  But boom and bust cycles are what keep the herd fit.  Imagine what those zebras and wildebeests would have evolved to if there were no lions and hyenas.  They would probably be fat, slow, and unable to run away from predators.  The business cycle is like the lion in the African plains.  It weeds out the weak and unfit. 

Staying out of recession because of big budget deficits isn't a sign of strength.  Its a sign of desperation and weakness.  The politicians have little tolerance for short term pain.  The same goes for most of the public, who absolutely loved the huge stimmies in 2020 and 2021.  

All these calls for a slowdown/mild recession in 2024 are using the old playbook for the old America.  The new playbook needs to account for the elephant in the room: the government.  The government has unlimited cash and can never go bankrupt.  It can always just spend more money.  This acyclical factor that keeps getting bigger is what has kept the US out of recession since the big rate hiking cycle in 2022.  The US has evolved into an economy that's reliant on huge fiscal budget deficits for growth.  Keeping track of projected government spending in 2024 at the state and federal level is probably your best guide to what to expect in the economy.  It seems like the consensus FY 2024 budget deficit projection is around 6-7% of GDP.  That's a lot of money going from the government to the private sector.  It will be less than 2023, thus you will get some economic slowdown, which you are seeing, but it also means getting a US recession in 2024 is not as likely as many think.  

The move over the past month was based on the Treasury reducing their planned coupon issuance, and also the dovish shift at the Fed.  Even if the Fed isn't outright saying they are done and will start cutting in 2024, the fact that they aren't pushing back strongly tells you a lot.  First, it tells you that Powell is no Volcker.  He's not playing for legacy, to avoid being Arthur Burns, to be like Volcker, as many postulate.  He's playing for longevity.  He is power hungry.  He wants to get re-elected Fed chair in 2025.  He's not going to get that done by being Mr. Hawk in an election year, and making Trump the next president.  Trump will get a lackey for Fed chair who will be dovish, no matter what.  He doesn't trust Powell, and will fire him in 2025.  

The Fed trajectory for 2024 is all based on politics and I fully expect Powell to surprise dovish throughout 2024.  I expect preemptive rate cuts, an attempt at a soft landing, and the Fed put whenever the stock market has a temper tantrum.  And I don't expect an economy as weak as many are projecting, especially for the 1st half of 2024.  So you will likely be seeing a much steeper yield curve as the Fed policies will be inflationary.  Treasury bonds are usually a good investment right before a typical Fed cutting cycle, but I don't think that will be the case in 2024.  Sure, you could get to 3.50%-3.75% in the 10 year yield if the stock market panics, causing Powell to panic cut.  But I don't expect a sustained move lower in yields like you would have seen in past cutting cycles.  Its because the market will sniff out that inflation and big budget deficits is a secular story and will price in higher long bond yields to compensate for the future supply. 

You are getting your garden variety pullback off a huge upward thrust.  I still see very little edge playing the SPX here, but I do expect it to break out above 4600 before year end.  I am surprised at the bond market strength, and it probably means you are not going to get much of a pullback in SPX this week or next.  While you could play for a quick bond short here tactically, I don't see much upside as I expect yields to remained contained for the next several days.  With the Fed going from hawk to dove, the animal spirits are returning and the volatility is dying.  Its not worth it to fight the rally in stocks at this stage.  You probably need to wait till spring of 2024, when we are on the doorstep of a preemptive rate cut before you can aggressively short SPX/NDX.  Right now, I'd rather be a buyer of dips than a shorter of rips.  But not that good of an opportunity, so mostly on the sidelines.