Oreos

Albert Edwards suspects a recession might be coming.

I do too, but… I don’t know, I wouldn’t want to put my relative pessimism in the same category as Albert’s.

Generally speaking, a calamity of some kind is always right around the corner, according to Edwards. That’s certainly the correct way to view the world, but in my experience, it’s not especially helpful when it comes to markets. The odds that “today’s the day,” so to speak, are quite low when it comes to economic and market catastrophes, and even in challenging environments, there’s no guarantee your downside hedges or long vol expressions will work.

Albert, like a lot of macro and market contrarians, doesn’t seem to let his dour prognostications get in the way of enjoying life. He’s an affable soul, he’s funny, gracious and self-effacing on occasion. By contrast, my own dour view of humanity is absolutely prohibitive when it comes to relishing life. In person, I’m cold bordering on unapproachable, my sarcastic wit isn’t always (or even usually) well-meaning, I’m not gracious and I’m humble only in the Socrates “I know that I know nothing” sense. In every other sense, I’m insufferably arrogant.

So, Albert is a nice guy who doesn’t let his penchant for dire prophesying get in the way of what, as far as I can tell, is a life well-lived, but can’t bring himself to be bullish on the economy or financial assets unless those assets are bonds. I’m not a nice guy, and my dire prophesying encroaches on my everyday demeanor at every turn, but I’ll turn bullish on the economy and especially on financial assets (any financial assets) at the drop of a dime if I think I can make a buck. That’s one reason (among many, I hope) people find my commentary helpful.

As it happens, my current view on the economy, assets and bonds aligns with Albert’s. I think a recession is coming, I think stocks are probably going to make “new” lows (where that doesn’t necessarily mean revisiting last October’s lows) and I think the bond selloff is a fade at this point (i.e., I’m relatively bullish duration at a time when duration “has no friends,” as one popular strategist put it earlier this week). I’m actually not sure if Albert thinks bonds are oversold currently, but he was on the right side of the bond bull for decades, and if he actually thinks a recession is coming, it’s reasonable to assume he believes yields are likely to retrace lower at least a little bit.

On Tuesday, Edwards asked a question: “As US bond yields surge ever higher, do you feel like you are in a car you just know is about to crash but are powerless to stop? All you can do is brace yourself and hope for the best.”

Yes. Yes, Albert, I do. And not just in the context of bond yields. That’s life in general. You’re in a car, you know it’s going to crash, you’re powerless to stop it and you can brace yourself and hope for the best all you want, but to channel Donnie Darko, “every living creature on Earth dies alone.”

Albert mentioned the term premium in the context of something John Authers wrote. If John wrote it, I skipped it. John is Albert’s “favorite early morning read.” Personally, I find John’s writing disappointingly generic, like an off-brand Oreo. Authers lures you with titles and topics market participants can’t resist, the same way Oreo knock-offs exploit your brain’s predisposition to eat all chocolate sandwich cookies. The voice of reason is there: “You’re not gonna like that. It’s not a real Oreo.” But the other voice is louder: “It says ‘short squeeze’ in the title, how bad could it possibly be?” 60 seconds later, you’re inhaling bottled water trying to wash away the cardboard aftertaste of a Twist & Shout.

Nobody ever accused Edwards of being generic, though. His pieces are more like real Oreos. You know you probably shouldn’t eat them, or if you do, you should’t eat too many, but they’re just so damn good — 60 seconds later, you ate the whole tray. A guilty pleasure, if ever there was one. To wit, from Albert’s Tuesday note:

The equity market’s current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors’ bullishness was eventually squashed. And in a further parallel, currency turbulence in 1987 played a key role in exacerbating recession worries for an equity market priced for the start of a new economic cycle. Just like in 1987, any hint of recession now would surely be a devastating blow to equities.

There you go. A dire warning complete with a 1987 reference. Albert may be old enough to retire, but he hasn’t lost a step. If anything, market participants’ appetite for crash hysteria is more voracious than ever. So, why hang it up now?

“Never in my career have I witnessed such uncertainty about where we are in the economic cycle,” he went on, before posing a question: “Is that long promised recession still lurking around the corner or are we at the start of a new economic cycle?” Spoiler alert: Albert thinks… well, I’ll just let him tell you:

My own view is that a recession still lurks, but like many I have held that view for a while now and have been proved wrong — so far. But there is still plenty of evidence to suggest a recession is imminent.

He quoted a Twitter account called “Game of Trades” in noting that trucking employment seems to be rolling over, which tends to happen before recessions. I can’t vouch for “Game of Trades” I’m afraid, but I hesitate to lay it on too think there given the “glass house, stones” dynamic vis-à-vis pseudonyms that some people might find juvenile.

Albert mentioned the SLOOS (“credit constraints [are] bearing down hard on economic agents”), a contracting money supply (“I wouldn’t call myself a monetarist, but when money supply weakness is confirmed in the data, I sit up and take note”) and, of course, bankruptcies (“higher interest rates are certainly taking their toll on smaller companies, as reflected in soaring bankruptcies”).

Ultimately, the most interesting part of Albert’s latest was simply the update on the dynamic he popularized over the summer: The collapse in corporate interest payments amid soaring rates. He updated his charts on that to reflect the BEA’s data revisions.

“Recent GDP benchmark revisions did little to revise away this massive decline,” he remarked, reminding investors that it’s “caused by the mega-caps borrowing cheaply long in 2020/21 and depositing short.”

Recall that although S&P 500 companies are certainly more insulated from higher rates versus small-caps, borrow costs rose for the S&P 500 on a YoY basis by the most in two decades last quarter, according to Goldman.

Still, the disparity between the Fed funds rate and net interest payments is remarkable. Post-revisions, Albert’s “maddest” chart is “even madder,” as he put it.

The figure on the left shows what the chart looked like pre-revisions. The figure on the right is post-revisions.

Even if you’re inclined to take issue with the charts (i.e., to suggest there are better, more exacting ways to illustrate the point), there’s a wild juxtaposition between rate rise and corporate interest cost, no matter how you choose to illustrate it.

If rates stay “higher-for-longer,” that’s going to “true up,” so to speak. Everyone has a maturity wall. It’s just a matter of how far out it is. In addition, it’s difficult to fund current operations with all cash forever. Eventually, companies do borrow. Assuming no deep recession which necessitates large rate cuts, and benchmarking against the rates which prevailed in 2020 and 2021, the cost of any new debt incurred will be dramatically higher.

As I put it a few days ago, lower interest costs, lower tax rates and falling COGS explain corporate profit growth. We’re now in a world of higher rates, higher taxes and higher input costs for everything from raw materials to labor. Suffice to say margin headwinds are myriad, and notwithstanding some compression from record highs, corporate profitability is still very robust on any historical timeframe. So, if anything goes wrong, there’s a long way down, potentially.

Finally, as a quick aside for my younger readers apropos of my unsparing tone on display above: I realize my overtly acerbic commentary can be a source of amusement. I also steadfastly believe that in a world full of doom merchants and pretend antagonists by day, upstanding, mild-mannered citizens by night, there’s something refreshing about the genuine article. But I implore you, don’t be me in your social, let alone your professional, interactions. The only place people like antiheroes is in movies, TV shows and on the internet.