Real Vision, the “Netflix of Finance”, started a series of episodes exploring the possibility of a recession on the horizon. Raoul Pal, Real Vision cofounder and mastermind behind the Global Macro Investor newsletter, opens the series with Is a U.S. Recession Coming?. What follows are my notes.
- The Fed possibly over tightened with interest rate raises and balance sheet tightening going into September 2018.
- Rates of change on 2 YoY peaked.
- Credit card interest rates at highs, while corporate rates are at lows (negative rates for some international junk bonds).
- Possible catalyst event with U.S. – China trade wars. Trump has targeted a lot of countries, now it’s China’s turn.
- Knock-On Effect: Companies trying to figure out what happens to supply chains developed in China. Can they shift to another country? What if Trump targets that country next?
- Instead of investing, companies sit on the sidelines, hire consultants to study their options. They’re wondering if they can outlast Trump.
- Spending freezes ➡ lower growth ➡ Recession
manufacturing + business cycle
- Raoul Pal (R.P.) uses ECRI instead of ISM to measure the business cycle.
- ECRI weekly YoY or QoQ rates of change
- ECRI vs Cass Freight Index, vs Capital Good Orders (non-Defense)
- Suggesting ECRI downturn
- Car sales⬇, Clothing ⬇, Retail Sales ⬇, Semiconductors ⬇.Weakness in house prices and new constructionThe aforementioned forward-looking indicators are gloomy, suggesting turnover in ECRI
- World PMI (Purchasing Managers’ Index) ⬇ (looking weak)
- Tariffs starting to impact trade volume ⬇
- Big problem if USD ⬆ much higher
- Germany headed toward recession + Italy + France (the top 3 European economies)
- China focused domestically this time, trying
to unwind their own bubble from all the cash they pumped out after 2008 financial
- Negative imports (no longer driving other countries’ GDP growth)
- Not in a position to provide global liquidity
- No single country can save the world this time.
- Yield Curve flattened, then inverted.
- UST 2-10Y curve is a predictor of recession.
- UST 1-2Y curve second most inverted in history ➡ typically followed by Fed cutting rates twice by 50 bps.
- Collapse in inflation expectations: much lower than desired by Fed
- Global deflation is happening despite low interest rates. Normally central banks lower rates to create inflation.
- Lower inflation means global debt becomes more expensive.
- Copper ⬇ , CRB (commodities index) possibly topping. Commodities about to bust?
- China: Probably won’t implode, looks relatively stable. Starved for USD, which could grow much stronger against the RMB (China’s currency)
- Strong Dollar
- Euro Stoxx chart looking dangerously like it’s heading to zero. (Index of European banks).
- Shortage of USD ➡ liquidity crisis
- European Central Bank (ECB) can cut rates, but inflation is still falling
- Doom loop (see below)
- ECB: Christine Lagarde (formerly of IMF) is taking over. Possible indication bank bailouts will be more important than monetary policy. This requires someone better in politics, like Lagarde, to cut deals.
- Ridiculous tech company valuations with leverage.
- Over ownership of Tech
- Facebook + Google anti-trust actions increasingly possible
- Corporate Debt = “Poster Child of Recession”
- Corporate debt is a function of the business cycle.
- New York Fed probability of recession at 30% (in this past, this has been a rock solid indicator of recession)
- Size of corporate debt as a % of GDP at
all-time-high (a huge explosion to $10 trillion)
- Used for stock buybacks ➡ stock prices ⬆
- Globally 50% of all corporate bonds are Junk + BBB
- Biggest BBB + Junk bond market ever
- GE, GM, AT&T, Ford, Dell = huge debts
- Debt/Equity rations get really bad if stocks ⬇
- Cash flows ⬇ when business cycle ⬇
- If big companies are downgraded to Junk (from BBB) ➡ Junk market gets obliterated
- A lot of debt will roll over during a recession
- Nearly all the debt is in USD, and there isn’t enough USD to go around.
- If USD ⬆ debt gets more expensive for everyone
- Business cycle ⬇ ➡ cash flows ⬇ ➡ can’t service debt ➡ stock sell off to raise funds to pay debt ➡ stocks ⬇
- Pension system is buying a lot of corporate
- Using tax receipts to buy bonds
- Business cycle ⬇ ➡ tax receipts ⬇ ➡ corporate bonds ⬇
- Baby boomers could become net seller to reduce risk. This could lower equities (stocks) for decades.
- Doom Loop
- BBB + Junk ➡ debt markets freeze ➡pensions sell (take losses) ➡ pensions switch to Treasuries at 1% or less ➡ bankrupts the pension system ➡ Boomers sell assets ➡ no buyers of equity or debt ➡ corporations are stuck + EU banking system fails ➡ Entire Financial System Freezes.
- Phase 1: Started October 2018. Business cycle weakens ➡ credit spreads widen ➡ corporate cash flow ⬇ ➡ stocks ⬇
- Phase 2: Coming Soon (after summer). Business cycle weakens more ➡ credit spreads widen more ➡ corporate cash flow + profits ⬇ ➡ tax receipts ⬇ ➡ pensions stop buying debt ➡ BBB & stocks ⬇ (hard)
- Phase 3: Boomers sell stocks ➡ BBB downgrades to Junk ➡ ECB bails out banks ➡ credit spreads explode + credit seizes up ➡ stocks collapse ➡ pension funds default + big companies in bankruptcy
- In the end, the Fed needs to take on debt (debt monetization) and underwrite the pension system.
- Buy bonds (especially shorter-term)
- Too dangerous to short stocks
- Buy Gold
- Buy Bitcoin