Macro Outlook

Macro Outlook

As some of you know, Strategic Wealth Partners had our Annual Forecast event last Thursday. The presentation went overlong, so my prep for what probably could have been a 30-minute macro-outlook extravaganza was shortened into a 45 second review of last year’s performance. That’s fine, but I turned my quick notes for the event into this blog. What am I looking at for this year?

Volatility

I’d think the primary word for the year is volatility. There are an enormous number of crosscurrents likely this year, and that creates fuel for enormous moves up and down moves. We’ve already seen some volatility this year, with an impressive rally in low-quality, high-beta names. That move was enough to make the year for those invested there, but the year is far from over.

Recession

A recession seems inevitable. Trailing data, such as jobs, still look pretty good, but leading indicators keep looking worse. Industrial production may no longer be a large portion of our economy, but it’s really been slowing down. Retail sales are a big portion of our economy, and those have also started to decline over the last few months. Leading economic indicators, like PMIs, orders, inventories, and business confidence are uniformly pretty grim.

The tougher question is just when we really start to see clear signs of a recession, with GDP shrinking. In theory, we could be seeing confirmation anytime, but based on history, something like the middle of the year seems most likely. Getting recessionary data is probably going to take a few months.

To be clear, recession is bad for equity markets. We haven’t priced in a recession, and we almost certainly won’t price one in before we get stronger recessionary data. We will see lower stock prices going forward.

Inflation

We’ve been seeing a pretty friendly interlude, in terms of things like friendlier inflation and easier financial conditions. What if that doesn’t continue in such a gentle line?

The next CPI report comes out on Tuesday, and there’s some concern it’s going to come in a bit hot.  We’ve been seeing inflation come in hot lately from several countries, like Germany, Mexico, and Brazil. Used cars and housing prices have started to turn back up. In fixed income markets, inflation breakevens are indicating investors are getting more worried about inflation.

The Cleveland Fed Nowcast keeps creeping up. Last month was originally reported at -0.1% m/m but got revised to 0.1%. The January forecast has gone from a 0.53% estimate to 0.65%, and the Feb. estimate is currently 0.61%. That’s starting to look like sticky 6-7% inflation, or at least could create worries of such…

Inflation rising would further cement the idea of the Fed keeping rates higher for longer, which is something the stock market has been pricing out so far this year.

Steadily lower inflation has helped ease financial conditions. In turn, that’s helped stimulate the economy, which encourages stronger inflation, as in our highly financialized society, more capital quickly gets put to work.

Financial Conditions

One of the main causes of improving financial conditions, paradoxically, is the debt ceiling. As the Treasury prepared for the debt ceiling fight, they flooded the market with T-bills. That’s basically a perfect storm for the market, as not only does it put money into the market, but it’s also the perfect competition for money in the RRP, so money has been coming out of there and into the market.

There are a couple of longer-term problems with that Treasury action, though. First, the Treasury is effectively dipping into reserves. When the crisis is over, that liquidity will just come screaming right back. Historically, when the government is strongly funding itself, other markets falter. We’re sowing the seeds of a future downturn.

Second, the market has strongly front run what was a reasonably modest improvement in liquidity. The last time we had a gap this big between market liquidity and the market was last August, and we saw the market have a pretty decent decline from there.

Summary

To sum up, this seems likely to be a tougher year than last year. By that, I don’t necessarily mean the market has to go down more than it did last year, just that the crosscurrents are harder. Liquidity is only going to get worse, which implies volatility will be higher.

That also implies we should see more credit risk problems. Some of that is likely to be from orchid-like companies that can’t handle this new world of higher rates and limited liquidity. Like in 2000, the market has been very reluctant to recognize how much the world has changed. Historically, raising rates causes problems, and taking away liquidity causes even bigger problems. I can’t think of a recession that didn’t see credit problems but that sure doesn’t seem priced in, here.

At the same time, we can’t take our ball and go home. We could easily be months and months away from a recession, and a lot can happen from here to there. Some years, not much happens. Some years, everything happens. This year seems likely to be the second kind.

While there are plenty of problems facing us, there are also plenty of opportunities. It’s easy to imagine the mix of inflation, economic activity, and employment change enough that the Fed pivots. Historically, that’s great for stocks, if only temporarily.

Also, while a recession is rough on stocks, it also sows the seeds of a new bull market. At some point in a recession, we should see a good opportunity to invest far more aggressively than we have been.

In sum, there are plenty of problems out there, but those problems can create good opportunities. Hopefully, we can use the likely volatility to our advantage to preserve and even grow the client’s assets.