‘It’s Not Inevitable’

However things turned out during Friday’s US session, this week was destined for inscription in the annals of market history, where it’ll be remembered for the exhausting, confusing and, depending on your perspective, wholly dubious, affair it most assuredly was.

It was the week during which a decade of deliberate, assiduously cautious policymaking gave way to eleventh hour Wall Street Journal warnings.

It was the week when 75bps Fed hike increments were made great again.

It was the week when European officials turned tail just four business days after inaugurating a tightening cycle.

It was the week Thomas Jordan reminded markets that the Swiss, at least, aren’t “in the business of forward guidance.”

It was the week the Bank of Japan refused to throw in the towel, choosing instead to recommit to unbridled money creation aimed at ensuring rates associated with a long-running circular funding scheme don’t rise.

And it was the week when global equities, aghast at the entire spectacle, fell nearly 6% over just four sessions on their way to a bear market and a tenth weekly decline in 11 (figure below).

“History is no guide to future performance but if it were, today’s bear market would end on October 19, 2022,” BofA’s Michael Hartnett said. The bank’s normally reliable Bull & Bear Indicator registered zero this week, typically a precursor to gains absent a systemic event. Or a deep recession.

Regrettably, advanced economies do appear to be headed for a downturn, it’s just a matter of how pronounced it’ll be. In the US, the news flow betrays a veritable recession obsession. Joe Biden says a downturn isn’t a foregone conclusion. “First of all, it’s not inevitable,” he told the AP, during a half-hour interview this week.

Forgive me, but yes it is. Recessions are always inevitable, and the US may be in one right now. The odds of Biden making it through his entire first term without the US meeting the technical definition of a recession are now exceedingly low. Consider the simple chart (below).

If the Fed delivers on its implied rate path, the amount of delivered tightening in 2022 will easily exceed anything witnessed in the US in four decades. And that’s without attempting to quantify the effect of balance sheet runoff.

With Q1 GDP already on the books as a negative print, and real-time trackers for Q2 on the verge of turning negative, to suggest the US is somehow going to muddle through without a recession is to be deliberately obtuse. In its semi-annual report to Congress ahead of Jerome Powell’s testimony next week, the Fed described its commitment to the inflation fight as “unconditional.”

That said, Biden is a victim of circumstance on virtually every front. That’s not an attempt to excuse ineffectual foreign policy and it’s certainly not to obfuscate about the role demand played in exacerbating what would’ve already been a highly inflationary conjuncture. But frankly, “the buck” doesn’t actually “stop here” when it comes to Biden’s fraught presidency. His is the most unlucky tenure I’ve personally ever witnessed, and I’ve seen more US presidents than a lot of Wall Street’s “best and brightest.”

In the same interview with the AP, Biden wondered,

If [inflation] is my fault, why is it the case in every other major industrial country in the world that inflation is higher? [Do] you ask yourself that? I’m not being a wise guy. Someone should ask that question. Why is it? If it’s a consequence of our spending.

His contention that inflation is higher “in every other major industrial country” isn’t strictly accurate, but his point is a good one. And since when does America require its presidents to adhere painstakingly to the facts?

Biden conceded that Janet Yellen did, in fact, tell him the American Rescue Plan could have a “marginal” impact on inflation. Yellen’s biographer recently claimed excerpts from an advance copy of his book, as reviewed and documented by Bloomberg, mischaracterized her views on Biden’s stimulus plan. In a statement, Yellen sought to dispel the notion that she once argued for a slimmed down version of the landmark legislation. “I never urged adoption of a smaller package,” she said.

Whatever the case, the risks to the world’s largest economy are skewed decisively to the downside, and there’s no help forthcoming from the Fed, which, as Nomura’s Charlie McElligott wrote Friday, is now operating on a “de facto sole inflation mandate.”

My own sense is that equities, both domestic and global, may have a window to rally over the next several weeks, before the reality of slower corporate profit growth sets in. Kroger’s margin shortfall and accompanying comments about consumers “aggressively” switching to store brands alongside a continual decline in basket size, were a harbinger. The shares fell 9% this week.

The figure (above) is trimmed for clarity — the week of March 3 featured an anomalous one-day surge which distorts the chart, as does a similarly outsized decline in the summer of 2017. Bottom line: This was among the 10 worst weekly declines for Kroger since Lehman.

Just as the economy likely can’t skirt a recession, neither can analysts continue to persist in the notion that current profit forecasts are realistic, not just in the context of expected future guidedowns, but even in consideration of what we’ve already heard from management teams over the last six or so weeks.

In a new note, Deutsche Bank’s Binky Chadha slashed the bank’s S&P EPS forecast for this year and next. He reminded investors that in post-War recessions, the median peak-to-trough decline in trailing EPS was 15% over 15 months. If the US is already in a recession or on the brink of one, EPS should fall from $217 currently to $185 by late next year.

Put a 14x multiple on $185 and what do you get?