Embedded Files
LIVE BITCOIN PRICE
2023 November 10
November 2023 Recession Comparison Model Update
The November 2023 update for my recession comparison model has just been released and is now available. This suite of graphics features new, updated data and includes a variety of improvements over my October 2023 visualizations; most significantly, my latest graphics include economic data from the 1966 Soft Landing, the only time in the last fifty years when a recession did not occur after inversion of the 3m-10y yield curve.
The primary takeaway? Five of the six NBER business cycle dating indicators (industrial production, wholesale, real income, non farm payroll growth, and employment as measured by the household survey) are running well within the distribution curve for this point in the economic cycle. One indicator, real PCE (consumption), continues to run well above the pre-recessionary average, likely reflecting an unprecedented high level of consumer savings following the pandemic. However, as economic pressures from elevated interest rates and the resumption of student loan repayments weigh on American consumers, I expect consumption will slow during Q42023/1H2024. Business cycle credit creation remains at the bottom of the pre-recessionary distribution, possibly forewarning increased economic turmoil in the middle-term.
As noted previously, I’ve also included data from the 1966 economic cycle, which was the only time in fifty+ years when an inversion of the 3m-10y yield curve did not fortell a recession. Thus, if the Fed does achieve a soft landing this cycle, we’d expect it to bear some resemblance to 1966.
A comparison between data from this cycle and the 1966 business cycle reveals that employment (and income) are the last remaining stools for the U.S. economy. Since credit growth has been very poor this cycle, the only way for Americans to continue spending and consuming is for the job market to continue to hold up. Put simply: if the job market breaks, the economy breaks.
The job market does seem to be showing signs of weakness. The November jobs report showed an increase in the unemployment rate from 3.8 to 3.9%, the highest since early-2021. The pace of job creation also slowed considerably in October, with the NFP number coming in well below expectations.
The next few months will be very telling regarding the ability of the United States economy to escape recession.
2023 August 1
The United States Economy Remains on Track for a Recession: An Economic Perspective Rooted on Reason, Pragmatism, and Historical Precedent
To my readers:
It’s been a long time (again) since we took a look deep down into the U.S. economy. In that time, there has been a lot of capitulation on the bearish side of the fence that, given the totality of the incoming data, has been completely unwarranted. We know that the labor market has proved to be relatively resilient in the face of the fastest rate hike cycle in history. We know that the stock market has been strong. Do these economic observations mean that we are out of the woods, that we have dodged the recessionary bullet?
No.
The primary thesis I want to talk about today is that it takes time for the U.S. economy to fully feel the effects of the Fed’s tighter monetary policy. Until then, neither a strong stock market nor a strong labor market can invalidate my recessionary thesis.
The only true invalidator to my recessionary thesis is time. And data.
We have established previously that it takes a considerable amount of time for the effects of the hiking of interest rates to work through the economy – as a general rule, most academics agree that it takes anywhere between 6-18 months for the economy to fully digest the effects of increases to the FFR. When we remember that the Fed has not yet finished hiking rates (though it is likely to do so in September), this extends the runway for potential economic fallout all the way through late 2024/early 25. The window of danger is long, and, in my opinion, we are just at its beginning.
We have also previously established that the stock market can perform relatively strongly during a pre-recessionary year. Indeed, we often see stock market booms prior to recessionary busts – ‘97-’99 is one example where we saw the S&P nearly double prior to the Dot-Com Bust of ‘00-’02. For an additional example, one must also take a look at the stock market’s uptrend during 2006 and early 2007, which was immediately followed by the GFC.
The performance of the stock market, or even the strength of the labor market, has historically had no predictive power on whether a recession is coming. In other words, it does not follow that we have avoided a recession because the unemployment rate is at 3.5% or because the S&P is at 4400. Every single recession has seen unemployment start at relatively low levels. Every single recession has seen the stock market bottom well after the NBER’s declaration of recession. To say otherwise would be to contest almost a hundred years of data that have all pointed to a single conclusion: recessions take time to form. Why should this time be any different?
Perhaps analogous to our discussion on recessions is the fact that every single pandemic starts with a single infected individual. Just because a virus has only infected one person during its early stages doesn’t preclude it from eventually infecting hundreds, thousands, or millions during its later stages.
Again, no factor can invalidate a recessionary call except for time. The performance of the stock market, the labor market, or any other economic indicator for that matter, has no power in proving that a recession will not occur.
What is more powerful, in my opinion, are comparisons between today's and the pre-recession periods of the past. By drawing parallels to past economic cycles, we can determine whether the phenomena we have seen thus far are akin to previous U.S. recessions. And if we think that the economy is likely to enter a recession, we might even be able to date when this occurs.
At this point, I want to point your attention to some work done by Arturo Estrella, Ph.D. who compared the U.S. Employment Index of this current Fed hiking cycle to that of other recessionary eras during 1968-2018.
As you can see, the U.S. job market is tracking relatively roughly with the 1968-2018 historical average following the first inversion of the 10y/3m yield curve. One point to make is that it is typically when the employment index turns over (i.e., turns negative) that we see the beginning of the recession. This makes sense, as employment is a key metric that the NBER uses to date recessions (think about the HOPE cycle!). We know employment is typically the last thing to break during a pre-recessionary period (and typically breaks once the recession begins).
According to Estrella’s data, the unemployment index typically turns over during months 12 and 13 after the first inversion of the 10y/3m yield curve. Since we know the 10y/3m curve inverted during October of 2022, that would put the beginning of the recession sometime during Q4 2023. At the latest, we might expect a recession to begin during Q1 2024 or Q2 2024 if things move particularly slowly.
I also assess that conditions on the ground are continuing to support the thesis that the labor market weakens into recessionary conditions during 2H 2023/1H 2024. When reading Zip recruiter's shareholder letter, I found these insights regarding the labor market particularly interesting:
“Both SMB [small-to-medium size businesses] and enterprise employers are posting fewer jobs while also spending less to advertise those jobs. This behavior runs counter to the seasonal hiring pattern we have typically observed over the many years we have been in business. The ongoing trend of reduced demand for recruiting services continues, and we believe this is a reality that companies across the recruiting category are facing
[...] In Q2 both SMB and enterprise employers continued to moderate hiring plans and reduce recruitment budgets in response to economic uncertainty. This has resulted in atypical seasonal hiring patterns, with online hiring demand declining over the first half of 2023.
[...] We had 102k Quarterly Paid Employers in Q2’23, a decrease of 35% year-over-year. The decrease in Quarterly Paid Employers is primarily reflective of weakness among small and medium-sized businesses.”
Weakness in the labor market is beginning to show, and I expect that this will only continue to occur with tightening credit standards and weakening economic indicators. And if the labor market continues to weaken, it follows from our previous reasoning that the economy enters a recession late this year or early next year.
As we explained previously, bottoms for U.S. equity indexes have always followed the beginning of the NBER-declared recession. So if we do enter a recession during Q4 2023 or Q1 2024, it would be plausible to think that US equity indices set new lows during 2024. This includes Bitcoin, which has to this point tracked pretty well with US equity indices (and is also a risk asset).
So, in conclusion, this is my economic thesis (be flexible with the timeframes!):
A weakening of the labor market over the next few months as interest rate hikes work their way through the economy and credit conditions worsen; NFP go negative and the employment index turns over late this year or early next year
Recession beginning Q4 2023/Q1 2024/Q2 2024 (probably latest case scenario)
US equity markets bottom out; Bitcoin retests $20k level and/or $15.5k level
Unemployment tops out around 4.5-6%. Fed pivots and cuts rates.
Fed runs QE and equity and labor markets recover during 2H 2024/1H 2025.
Again, my thesis remains very uncertain. Q4 of this year will be a critical “main-or-break” time for my recessionary thesis. Only time will tell what happens to the U.S. economy.
I wish you the best in navigating these markets.
2023 May 18
The United States Economy in Turmoil: A Pragmatic Perspective on the Banking Sector's Woes, Sticky Inflation, and the Debt Ceiling
Good afternoon,
I know that it has been a long while since my last update here, and I extend my apologies for my absence. I had a substantial workload since mid-March that placed increasingly large demands on my time. Having recently completed my college finals, however, I anticipate that I will be able to devote more time to putting out updates on financial markets. That is the hope, at least.
A lot has occurred in financial markets since my last update. Volatility in the U.S. banking sector has continued, though the Federal Government took extraordinary measures to minimize the fallout from March’s bank failures. In mid-March, the Federal Reserve created the Bank Term Funding Program, a fund that provides emergency loans to banks, and backstopped all deposits to Signature Bank (another regional bank that failed in March) and Silicon Valley Bank (as discussed in our March update). These measures were designed to calm financial markets, and they appear to have been successful for the time being; for the most part, bank runs across the regional banking system ended following the Federal Reserve’s actions. However, I should mention that I do not believe that the Federal Government’s actions are indicative of a restart of quantitative easing. The Federal Reserve continues to roll assets off of its balance sheet (despite a brief increase in the value of the balance sheet in mid-March), and it continues to maintain its hawkish stance on monetary policy. The Federal Reserve’s main goal, as has been expressed by Fed Chairman Powell, has been to return inflation to its 2% mandate with as little turmoil to financial markets as possible (hence the attempt to achieve a soft landing). And if that is their goal (which, considering the Federal Reserve’s persistence in messaging and action, I think it is), then we should interpret the Fed’s actions as being made in support of that goal. I thus interpret that the Federal Reserve’s actions were made to extend the runway for a period of heightened interest rates to prevent the United State economy from economic recession before the fight against inflation is won. The rumors of QT’s demise have thus been greatly exaggerated.
Despite the Federal Government’s interventions, turmoil in the banking sector continued. On April 29, the FDIC announced that it would be taking over the assets of First Republic Bank, another regional bank based out of California. The FDIC’s announcement precipitated a bidding process for the bank’s assets, ending with the bank’s sale to JP Morgan. First Republic’s collapse occurred despite the actions taken by the Federal Reserve to support the banking sector and a $100 billion capital infusion exclusively to First Republic from major U.S. banks!
Of course, I should not forget to mention UBS’s late March buyout of Credit Suisse. We actually spoke about the prospects of Credit Suisse’s collapse all the way back in October (especially with regard to Credit Suisse’s rising CDS prices).
Turmoil in the banking sector has continued to spread since late March. Nearly two weeks ago, Pacific West Bankcorp, another regional bank based out of California, announced that it was exploring options for a sale. The developments in the banking sector, to me, confirm the belief that Silicon Valley was not the only bank under pressure due to their irresponsible decisions regarding long-term treasury bond investments. However, I reiterate my view that most (though certainly not all) U.S. banks remain sound at the moment. We’ll probably have continued banking instability, but again, I do not expect a 2008 collapse. Could conditions worsen into Q4 2023/Q1 2024? Of course, and I do expect them to. But considering all the liquidity that remains in the system from the 2020-2021 QE cycle, it will take time. Most probably, the weakness in the banking sector represents a prelude to a period of greater financial instability at the end of the year, particularly due to the effects that tighter lending standards will have on economic growth.
What I see as further evidence to the effect that financial conditions will weaken going into the end of 2023 is the fact that the Federal Reserve remains resolute in its conviction to get inflation under control. At the May 2 FOMC, the Fed raised rates by another 25bps to a target rate of 5.00-5.25%. Yet, despite all the work the Fed has done in tightening financial conditions over the last few months, more work must be done. Inflation has remained sticky – core PCE inflation, while certainly in a downtrend, has been slow to fall and has recently gotten stuck around the 4.5-5.0% YoY mark. Core inflation, which excludes the volatile food and energy sectors from headline inflation, has been stuck around 5.5% since the beginning of the year. Additionally, the labor market remains extraordinarily tight, with the unemployment rate at 3.4% (a secular low), while wage inflation remained very high at 0.5% MoM. Until the balance between labor demand and supply is stabilized, a sustained period of low inflation in the U.S. economy can not be reached. There is absolutely no reason for the Fed to pivot. In fact, most of the incoming economic data suggests that the Fed must stay higher for longer in order to lower inflation (and thus create a sustained period of economic growth).
What is perhaps of more immediate (albeit, still limited) concern at the moment is the U.S. debt ceiling. At the moment, the Treasury suggests that the Federal Government will exhaust its “extraordinary measures” around 1 June and thus may not be able to meet the financial obligations of servicing her debt burdens. A lot of commentary has focused on the effects of any potential default (which makes sense, considering the fact that news media of the day appears to be driven primarily by hysteria and fear), so I’ll try to bring light to other aspects of the situation; while a U.S. default is certainly on the table, I believe that the hysteria surrounding it is somewhat misplaced. The Federal Government can easily avoid a default by raising the debt limit (though whether they actually will is a question that I cannot answer). I would humbly suggest, however, that the politicians in Washington are acutely aware of the risks that a debt ceiling breach poses not only to the U.S. economy (mass unemployment and a significant, possibly deep, recession) but also to their political reputations. With a major election cycle upcoming in 2024, a political crisis is probably not very appetizing for most politicians. Another nuance that is often missed by most commentators, I think, regards the conditions of any compromise met on Capitol Hill to avoid a default. Does the compromise entail less spending by the U.S. Government? If so, which services will be affected? And how will tighter fiscal policy affect economic growth? Or does the compromise just include a raising of the debt limit (how long can we keep that up for)? I will have more to say on the debt crisis if/when a compromise is reached. Until then, the answers to these questions will remain uncertain. What is certain is that Washington will have to act quickly and decisively within the next few days to prevent an economic calamity with unpredictable consequences.
I think that’s all for now – this post is getting a bit long anyway. We’ve got a long road ahead of us, folks. Be nimble, flexible, and cautious in the way that you approach financial conditions within the next few months.
Thanks for reading, and all the best,
Kenji Ryu
2023 March 12
The extremely concerning prelude to a period of severe economic downtown: A rational perspective on the current market situation
Good morning,
The United States economy is under severe strain. Financial markets are currently in significant turmoil following this week’s instability in the banking sector. However, I believe that a rational perspective on this week’s events reveals that they are likely only the prelude to a much more severe economic event later this year. It is unlikely that the weakness in the banking sector proves to be a catalyst for a catalyclysmic economic event in the near-term. But what is likely is that they are the preview for one within the next 6-12 months. I will have more to say on this matter after briefly reviewing this week’s developments in the financial sector.
The principal cause for the deterioration in financial sentiment this week was the collapse of Silicon Valley Bank (SVB), which was the 16th largest bank in the United States at the time of its collapse. Deteriorating confidence in SVB’s ability to honor deposits last week catalyzed an extremely rapid bank run on deposits. By 10 March, California regulators officially shut down SVB and secured the remainder of its assets in order to protect investors. From start to finish, the fall of SVB took only about 48 hours. The collapse of SVB constitutes the largest bank failure since 2008, and the second largest in United States history. SVB’s investors, which include nearly 50% of U.S. startups, lost a total of ~$161 billion in the bank’s collapse. Around 93% of SVB’s investor deposits (~$150 billion) are uninsured by the FDIC’s $250k rule. It is hard to overstate the pain and suffering that the collapse of SVB has and will continue to cause.
It is important to note that the causes that contributed to SVB’s collapse are not unique to SVB. Fundamentally, SVB’s liquidity crisis was caused by severe losses in its Treasury Bonds investments. Following the COVID-19 Pandemic, SVB invested a large portion of its deposits into longer term treasury bonds in order to achieve a higher yield than would have been possible with shorter term bonds. However, the rise in inflation during 2021 and 2022 from pandemic-driven stimulus contributed to a rapid repricing of treasury bonds (and the eventual inversion of the yield curve). For this reason, the yield from shorter term bonds, when compared to that from longer term bonds, fell significantly. As a result, SVB suffered from a large number of unrealized losses in its Treasury Bond department. It is true that SVB is likely not the only bank to be irresponsibly long on longer term treasury bonds leading into the rise of inflation. However, it is also possible to overstate the similarities between SVB and the majority of the financial sector. Financial institutions today generally have a much more diversified portfolio than simply being long on long term treasury bonds, a result of the increased regulations placed on banks following the Great Financial Crisis. Thus, SVB’s problems may apply to a few other major banks, but they are unlikely to affect all U.S. banks. Analogs between SVB’s collapse and 2008 are generally wrong at this point, I believe. In 2008, most U.S. banks had a similar portfolio and were all significantly levered up on MBS products. Thus, a decline of MBS asset prices led to significant turmoil in all banks exposed to MBS products. In 2023, things are significantly different. Could SVB’s collapse be indicative of the root causes that ultimately lead to the collapse of more banks? Sure. But will they be the immediate cause of a 2008-style banking crisis? I don’t think so. What is more likely is that they are the prelude to a more catastrophic financial crisis.
What is more concerning to me is the fact that the collapse of SVB has occured at a relatively early time in the Fed’s hiking cycle. The Fed hasn’t even pivoted yet, and if Chairman Powell’s comments this week are any indication, they are unlikely to do so anytime soon. The labor market remains far too overheated, despite some mixed signals in this month’s employment report (The U.S. economy added 310k new payroll jobs, but the unemployment rate rose from 3.4% to 3.6%). The current CPI inflation (6.41%) remains significantly higher than the Fed’s inflation mandate (2.00%). So, the Fed is likely to continue hiking into the foreseeable future. The markets agree – currently markets see a 68.3% chance of a 50bps hike at the March FOMC. However, the fact that the economy is showing strain this early is extremely concerning. Past research reveals that it takes approximately nine to twelve months for the full effects of rate hikes. The first rate hike (25bps) was twelve months ago. We have yet to see the full effects of the remaining 425bps hikes from the rest of 2022. And turmoil is already arising in the financial markets. If history is any indication, things will only worsen from here as the full effect of hikes is felt. The United States economy is unlikely to be able to weather a sustained period (>six months) of rates at 4-5% without something breaking. There are already cracks showing, and they will probably only continue to widen.
Conditions in the U.S. debt market also suggest that a severe credit event is possible in the 2H 2023. Data from Moody’s shows that nearly 24.8 million Americans are delinquent on their loans, a number that hasn’t been rivaled since the depths of the Financial Crisis. And if we assume that conditions in the labor market will cool (as the full effects of rate hikes become more clear), how bad will this number get? While it is true that the total amount owed by Americans is generally lower than it was in 2008-2009 (due to fiscus stimulus), it doesn’t have to be that high to cause severe damage to American families and businesses. The American consumer is already weak and is vulnerable to a severe, prolonged credit event.
Let’s also not forget the U.S. sovereign debt ceiling crisis. At the current rate, the U.S. Government will surpass the debt ceiling limit by June this year, constituting a selective default. The potential repercussions from a U.S. government default are likely to be extremely severe and damaging to the United States economy.
Current financial conditions remain complex and complicated. It’s possible that the Fed decides to pivot to a more dovish fiscal policy ahead of what is currently expected (thus exposing the economy to the risks of both prolonged inflation and/or a crippling recession). It’s also possible that they keep hiking in the summer. However, they don’t have to in order to cause severe damage to the economy. That has probably already occurred/is occuring, for the full effect of rate hikes won’t be seen untl later this year. My base case at this moment remains a severe, prolonged recession that begins somewhere around Q42023/Q12024. Economic conditions will worsen. Prepare accordingly.
Let us end with a note of positivity. We should remember that periods of economic downturn typically lead to fantastic buying opportunities. There are likely generational opportunities coming for a wide variety of asset classes.
I wish you all the best.
2023 February 2
Analysis of the 1 February 2023 FOMC/Big Tech Earnings
To all readers,
Yesterday, the Federal Reserve raised the Federal Funds rate by 25 bps, for a target rate of 450 to 475 bps. Today, I want to discuss some of the implications from yesterday’s FOMC and my general thoughts on the meeting.
Jerome Powell adopted a notably more dovish tone in yesterday’s FOMC. For the first time in this business cycle, Powell noted that the “deflationary process” had begun and that inflation has “moderated recently.” Powell mentioned that the U.S. economy “slowed significantly last year,” and that financial conditions had tightened significantly since last year: the housing sector continues to weaken and goods inflation is falling relative quickly. However, Powell maintained some of his past hawkisness. For example, he re-emphasized that further work was required to reduce inflation to the Fed’s 2% mandate, and that it was “premature to declare victory” in the fight against inflation. In addition, Powell expressed that further rate increases would be necessary, implying that 25 bps hikes would extend at least into the March FOMC. Powell also said that he did not foresee rate-cuts through the end of this year, though that would be dependent on the rate at which inflation fell in the United States, and that the United States could not sustainably return to 2% inflation without a better balance between demand and supply in the labor market.
I believe that investors should not take Powell at face value. For example, Powell stated that financial conditions had tightened significantly since last year. However, data from the Chicago Fed (shown above) shows that financial conditions have eased significantly from their lows in October, and are comparable to levels seen in Q1 2022. We’ve seen the effects of this easing of financial conditions in equity markets – the S&P is up nearly 10% year to date. Why would Powell say that financial conditions have eased now, instead of sometime earlier? I think to answer this question, we should ask what would cause the Fed to pivot to dovish monetary policy. We saw a notable shift in the Fed’s philosophy to a more dovish tone, so finding the root cause could help us answer the question above.
In previous business cycles, the Fed has pivoted from a hawkish to dovish monetary policy when the market showed weakness (when the unemployment rate started to rise). Consequently, I evaluate that the Fed may be attempting to set conditions for a pivot due to worsening economic conditions in the United States. But even then, Powell made it clear that he didn’t foresee rate cuts/a pivot before the year’s end (unless inflation fell more rapidly than expected). Can the economy really survive 4.75-5% rates for a year? There are no clear answers – but I am skeptical, to say the least.
And we’ve seen tech companies start to weaken even now. New orders and manufacturing data has continued to disappoint – manufacturing indices have underperformed expectations. Apple, Google, Amazon, and Microsoft, four of the biggest American tech giants, have all missed expectations for Q4 2022 earnings (shown above). Many tech companies are beginning to cut workers. What could this forebode for the economy?
I assess that rapid deflation of the U.S. economy will be a significant threat for the next 12-18 months. The market is already showing signs of weakness, and we know that rates will remain elevated for at least the next year. I foresee significant difficulties in the United States equities market for the next year. However, I realize that financial conditions are extremely changeable and difficult to decipher. My fund will remain flexible to market conditions and will adapt accordingly.
2023 January 9
Is the Bottom for U.S. Equities in? If not, when might it be?
To all readers,
First of all, happy new year! I hope that 2023 is starting off well for you and your family!
I wanted to start the New Year off by sharing a model I've been working on for the last week or so. As I’ve constantly expressed over the last few months, my base case for the next few years is that a recession, possibly severe and/or prolonged, will affect the United States economy. Over the last few months, I’ve discussed a few pieces of evidence that suggest that a recession is likely. For example, the spread between the 10-year and 3-month treasury bonds recently inverted to its deepest point since the Dot-Com Bubble. Prior to every recession within the last 25 years, the spread between the 10-year and 3-month treasury bonds inverted, suggesting a strong correlation between recessions and this yield curve inversion. In that way, this most recent inversion suggests that a recession is likely.
There are indications that this recession is beginning. Recently, Apple reduced its orders for components for AirPods, MacBooks, and Apple Watches due to decreased demand. As decreased aggregate demand drives recessions, this is likely one sign of an imminent recession. Of course, this doesn’t mean a recession WILL happen (nothing is ever certain), but it is strong evidence to that effect. From a probabilistic standpoint, a recession is likely to occur.
Let us, therefore, assume for a moment that a recession will occur. When might a bottom for U.S. equities occur?
To answer that question, I’ve assembled a model utilizing data from the last eight recessions, as defined by the NBER. We know that the NBER has not officially declared a recession yet, so if we can find some interesting trends in the data from NBER-defined recessions, we can apply that to this current recession. NBER declarations of recessions provide convenient control variables, from which we can draw some generalized trends and observations.
As we know, NBER declarations are an imperfect measure of when a recession occurred. For example, during the Dot-Com Bubble, the official NBER declaration came almost a year after unemployment reached its low. For the time defined as the recessionary period, I’ve defined the start date as when unemployment reached a trough and the end date as when unemployment peaked. It’s an imperfect variable, but it’s not too important anyway. Its only purpose is to show the imperfections of the NBER declarations and to explain some of the stranger trends that arise in the Dot-Com Bubble. Remember that the NBER declaration is what we really care about.
There are some clear trends we can notice in the data. As we can see, in every single NBER recession, the days to the S&P bottom after the NBER recession began are always positive, meaning that, in every recession, the S&P 500 bottomed after a recession was officially declared. The amount of time it took for a bottom to form varied from recession to recession, from the COVID recession’s 51 days to the Dot-Com Bubble’s 588 days.
We can take the arithmetic mean of the days to the S&P bottom by adding together all of our data points and then dividing the sum by the number of recessions (eight). Doing this gives us an average value of 276.375, meaning that, on average, the bottom for the S&P 500 came about 276 days after the NBER declared a recession.
Okay, so those are some pretty interesting observations. But we know that the length of recessions varies from case to case. For example, the COVID-19 Recession lasted a mere 59 days, while the 1981-82 recession lasted more than seven times that, clocking in at 488 days. By taking the percentage of the NBER-defined recession completed on the day of the S&P bottom, we can adjust for the differing lengths of each recession.
As a note, the outlier of 240% is because the NBER defined the Dot-Com Bubble from March 2001 to November 2001. I simply took the S&P bottom for the entire Dot-Com Bubble. Since the Dot-Com low came in October 2002, this leads to an outlying value, with respect to our other data points. As such, when I calculated the average percent, I simply excluded the Dot-Com value and took the average of the remaining seven data points. Doing this gives us a value of 66.54, implying that the S&P bottom comes about 66.54% of the way through the NBER recession. I should note, however, that this number is not very precise; the standard deviation of this set of values is 19.10!
Another thing of note is the fact that the market cycle bottom for stocks occurs before peak unemployment. As we know, the stock market is not the economy. And of course, for many Americans, the unemployment rate is more important than the stock market. By taking the peak-to-trough period for unemployment, we can determine when we might expect unemployment to peak once the NBER recession is declared. Taking the average of our six data points gives us a total of 501.75, meaning that unemployment peaks more than 500 days after the NBER declaration. The difference between the average number of days from the NBER declaration to the S&P bottom and the number of days gives us a value is 225, meaning that peak unemployment causes more than 200 days after the S&P bottom. This difference speaks to the forward-looking nature of markets, and how they effectively “price-in” a recessionary bottom before it actually occurs.
So, in conclusion, the following observations can be made from this analysis:
i. The bottom for the S&P always came after the NBER declaration of a recession.
ii. The stock market bottom occurs before peak unemployment.
We can also provide some generalizations on the time aspect as well, but these are a bit more dubious than our main generalizations. Applying these two generalizations to the 2022-23 stock market downturn implies that the stock market bottom is likely not in, since the NBER has not officially declared a recession yet. If history is any indication, the peak in unemployment should occur after the S&P bottoms, implying that a significant amount of pain is likely ahead for the U.S. economy.
If I had to take a guess on when the U.S. might enter recession, I would put the timeframe as being sometime during Q42023-Q12024. We know that interest rates take time to work through the economy (typically 12-18 months) and so that would probably be the period of greatest risk.
--------------------------------------------------
2022 December 2
Conditions are favored for a severe price deterioration in US asset markets
To all readers,
I believe that signs are pointing to a deterioration in the valuation of US stock markets between now and sometime during 2023. There are a wide variety of indicators that continue to suggest that a recession is likely, if not already ongoing.
I will first provide a summary of Fed Chairman Powell's speech on November 30, 2022, and the most recent United States jobs report on December 2, 2022. Then, I will provide a few thoughts on why a "pivot" is not a good thing (if it does occur). I'll end by pointing out a striking discrepancy between S&P 500 returns and US 20-year yields.
Chairman Powell's November 30, 2022 speech took on a notably more dovish tone than his previous 2022 speeches have. At the end of his speech, Powell noted that the time for slowing of rate increases may occur at the December FOMC meeting, implying that the rate hike may only be 50bps instead of 75. Powell also addressed the risk of pursuing over tightening monetary policy. To manage that risk, Powell noted the Fed would need to slow rate increases in the near-future. Powell constantly emphasized both in his speech and in the subsequent Q&A session that he did not want to over-tighten. Powell also briefly addressed the idea of a "soft landing" during the Q&A session (i.e., getting inflation back to the 2% goal without triggering a severe downturn in the US economy). Powell stated that he believes that a soft landing is still achievable.
Though Powell did provide some dovish comments, I perceived that the tone of his speech remains predominantly hawkish. As he has said throughout the majority of 2022, Powell noted that history warned against prematurely pivoting to a dovish monetary policy. Powell also argued that inflation was "far too high", and that the terminal rate for the Federal funds rate would be at a point higher than that expected at the September meeting. Powell also stated that there was insufficient evidence to suggest that inflation had peaked.
The markets reacted strongly to Powell's speech. The SPY broke through $395 and headed immediately to $405. It closed the day at $407.68, up more than 3% on the day.
We also got new employment statistics from the Bureau of Labor Statistics today. The unemployment rate remained constant at 3.7%. However, non farm payrolls beat expectations, as the NFP rose by 263,000, compared to the expected 200,000. NFP payrolls and the unemployment rate are another indication that the labor market remains stubbornly heated. Bringing inflation down will likely require some cooling of labor market conditions. Remember that monetary policy implemented by the Federal Reserve has a time lag of approximately one year before its effects are fully felt. As the Federal Reserve only really began to hike rates in March 2022, one could argue that the affects of these rate hikes will not truly be felt until Q1 2023, at the earliest.
Since Powell's speech, there has been a lot of talk over a "pivot" from hawkish to dovish Fed policy. Personally, I do not agree. Powell has said that the Fed "will stay the course until the job [of breaking inflation down] is finished". I see no reason to doubt it. But for the sake of argument, let us assume that a pivot is on. Then what? Will the U.S. economy return to a period of incredible growth again? If history is any indication, the answer is no.
The following are three charts that show the performance of the S&P 500 following a pivot by the Federal Reserve. Let us define a pivot as a switch to rate decreases after a period of rate increases. For clarity, the pivot is shown by a blue vertical line.
The first example is the Dot-Com Bubble, where the Fed slashed rates from 625 bps to about 100 bps. After the Fed started cutting rates, the S&P fell by another 40%.
Okay, let's try the Financial Crisis then. In 2007-2009, the Fed cut rates from 525bps to 25bps and ran quantitative easing. Once the Fed started cutting rates, the S&P 500 fell by nearly 53%.
What about COVID? During COVID, the Fed started slashing rates on 3 March. By then, the S&P 500 had already fallen substantially. But its drop paled in comparison to the drop that followed. From 3 March, the S&P 500 fell 30%.
The point is that Federal Reserve pivots have often been followed by a hard landing anyway. A pivot is not necessarily a good thing, then, as it has historically preceded a severe downturn in US assets. While historical performance does not necessarily predict future performance, it gives a good idea of what can happen.
I wanted to close today by describing an interesting relationship between US 20-year treasury yields (TLT) and the S&P 500. Traditionally, risk-off periods have seen a flight to safety from US stocks. Investors generally trust the US government to pay off debts, so heading to bonds is a good way to ensure a substantial return while managing risk. 2022 has been a different story.
Above is a chart comparing peak to trough returns for the S&P 500 and the return on 20 year bonds (TLT) for the same period. In the last five major stock downturns in the 21st century, treasuries have often outperformed the S&P for the reasons listed above. In 2022, treasures have actually underperformed the S&P. This suggests that treasuries may rally into the end of 2022, concurrent with a collapse in the price of stock assets, as happened in 2008.
Combine this with the yield curve inversions that have developed in the last few months, and worsening economic conditions will continue to occur. Conditions are primed for a rapid downturn in the price of US stocks. A pivot will not save the economy.
--------------------------------------------------
2022 November 10
The fall of FTX and an early look at its wider implications on crypto
To all readers,
It has been one hell of a week for the cryptocurrency industry. After months of holding support at the $17.5-20k area, Bitcoin finally lost the line. Bitcoin has now set a new low for this bear market at $15.5k. One of the largest cryptocurrency exchanges, FTX, has been ousted as being completely illiquid and is on the verge of bankruptcy. Let's dive into it.
I'll first provide a summary of this week in the cryptocurrency markets. Then, I will discuss the potential implications for the market. I will end today with some brief comments on how I am preparing for this next phase of the bear market and the measures that my fund is prepared to take going into 2023.
First off, I'll start with a summary of the last week and the monumental shifts in the cryptocurrency space. Last Wednesday, CoinDesk completed an investigation that found that most of the holdings of Alameda Research (the predatory arm of the FTX exchange) were in illiquid trashcoins. Worse, the report found that a large percentage of Alameda's value was in the FTT token, which is used only on the FTX exchange. Therefore, most of FTX's collateral (and thus, its assets) were in its own token. Furthermore, another interesting thing is that the market cap of FTT was approximately $3-4 billion prior to the collapse. The FTT holdings which Alameda reported were worth approximately...$3.66 billion. This implies the majority of the market cap of FTT was held by FTX. In other words, FTX held the majority of FTT's market cap, which FTX called an "asset" (and which FTX used as collateral).
After these rumors emerged, a massive wave of capital withdrawals from the FTX exchange emerged. I remember seeing estimates of $5 billion worth of withdrawals from FTX on twitter. This effectively constitutes a bank run, and by Monday, FTX was suffering a severe liquidity crisis. At the same time, one of FTX's main rivals, Binance, announced that they would be liquidating any remaining FTT on their order books. This only worsened the liquidity crisis that FTX was suffering.
Things worsened dramatically on Monday night. That night, FTT lost a key support level at $22 that it had held since its inception. The token has since plunged to $3, representing a nearly 85% drawdown from its pre-crisis levels. Due to FTX's inability to honor investors' withdrawal requests, on Tuesday afternoon, the CEO of FTX, Sam Bankman-Fried, asked the CEO of Binance, Changpeng Zhao, for a bailout. That day, Binance came to a non-binding agreement to acquire FTX.
When FTT lost its support at $22, BTC also tanked to ~19k. There was a brief bounce on November 8 when Binance announced that it was considering an acquisition of FTX, but that was quickly sold off and BTC continued lower. BTC set an initial low at $17.2k on the afternoon of November 8, breaking the $17.5k support which had held since June.
FTX's situation continued to worsen on Wednesday. That day, the US SEC launched an investigation into FTX. Worse, Binance announced that after it had conducted corporate due diligence into FTX, it had decided not to acquire it. Almost immediately after this announcement, BTC underwent a dramatic short-term capitulation event all the way down to $15.5k.
FTX is now insolvent and is attempting to gain funding to close a $8 billion hole in its balance sheet. This is a calamitous event for cryptocurrency and represents one of the worst scandals to strike the market since its inception.
Though we had spoken at length of the possibility of a crypto capitulation event in November, now is not the time to say "I told you so!". The insolvency of FTX means that thousands have lost incredible amounts of money. Many had large portions (or indeed, all) of their net worth on FTX. Its insolvency implies that a large portion of this money is lost unless FTX can acquire funding. I cannot overemphasize how much of a disaster this is for the crypto space. The loss of credibility that results from the insolvency of FTX (and how public it was) will take years to recover from.
I also believe that regulation will be coming for the cryptocurrency space. Ultimately, this can be a good thing. While I like cryptocurrency for its decentralized nature with respect to other assets, that decentralization is also the element that is to blame for the failure of FTX. The lack of regulation of the space implied that companies like FTX were able to propagation without any sort of accountability. Investors who lost money in FTX are not FDIC-insured, which means that they cannot get their funds back. Ultimately, some sort of regulation will be a good time for this space. I just hope that they don't go too far and end up killing a great space and a great technology.
If there's one lesson we should learn from the insolvency of FTX (or rather, relearn), it's that any assets held on a centralized exchange are not yours! Remember the saying: not your keys, not your crypto. Withdraw all of your crypto into cold storage! Take it off exchanges! If it's not on the exchange then they cannot take it from you and you reduce your risk.
I do not believe that BTC has bottomed yet. Thus far, we have seen relatively orderly selling, and I do not believe we have seen a capitulation event. THe market does not seem to have realized that we are on the cusp of an even worse catastrophe in the crypto space than we have already had. FTX will not be the last insolvency in the space. Just like Luna, Bitconnect, and Mt. Gox before it, FTX exemplifies the fragility of an unregulated space. There will be more failures. Crypto should go lower than $15.5k.
I'll close today with a brief work on what measures the fund is prepared to do. As we have said since May 2022, cash will be king in 2022. Ultimately, I do believe that the US asset market and the cryptocurrency market will recover. If there's anything I will bet on in these uncertain markets, it's that the US economy and cryptocurrency market will eventually recover. Crypto is no stranger to tough times. Each time, it has returned to its previous highs and gone higher. I do not know how long that will take, but I do believe that it will occur.
Once the market provides a more convincing bottom, mu fund will utilize our liquidity to buy assets in the markets. I do not hope to time the exact bottom, but that's okay. As long as I can get a price that is "good enough", I will be satisfied. Is there really a difference between an ROI of a 5 or a 5.5 in a long term swing?
As a reminder, I have spent 2022 aggressively accumulating cash so that we are well-positioned to take advantage of the coming recession. I remain committed to reaching my $100,000 goal by 2025, and I will take decisive action to ensure that I fulfill our goal.
--------------------------------------------------
2022 November 2
The Fed WILL remain hawkish at today's FOMC.
Just wanted to provide a brief reminder all that the Fed will remain hawkish. There is absolutely zero reason for a pivot to dovish messaging. Inflation remains elevated, the labor market remains heated, and the economy remains resilient. There will be no pivot. Position accordingly.
--------------------------------------------------
2022 October 20
Is a Bitcoin capitulation coming in November?
Today, I wanted to discuss the similarities between the 2018 Bitcoin bear market and the current 2022 Bitcoin bear market. Remember that all models are wrong, some are useful, and we should consider as many models as I can so that we can be ready for all scenarios.
In June 2018, Bitcoin capitulated to $5,700. For the next five months until November 2018, Bitcoin held support at this $6k support level, with occasional wicks below. In November 2018 (also a mid-term year!), the $6k floor gave out. Bitcoin capitulated, falling nearly 50% to $3.1k.
There are indications that the 2022 bear market is similar to the 2018 bear market. In June 2022, Bitcoin capitulated to $17,500. For the next four months until October 2022, Bitcoin held support at this $20k support level, with occasional wicks below. This begs the question: is November 2022 going to be a capitulation month for Bitcoin? Will the $20k support level finally give out?
I should emphasize that history never plays out the same way. But, in many cases, history does rhyme. Remember that like 2018, 2022 is also a mid term year. Furthermore, like 2018, 2022 has had a period of quantitative tightening from the Federal Reserve.
If November 2022 is to be a capitulation month, what could the catalyst? There is a wide variety of elements that could influence the price of Bitcoin, including the November FOMC, the US midterms, and the November CPI data. I do not know whether a capitulation will occur, but I do know that there are many similarities between our situation in 2022 and the situation in 2018.
Our readers should remain assured that we are well prepared for any eventuality. As my readers on Instagram will know, I stated in May 2022 that "cash is king". In the case of a capitulation event, we have the liquidity necessary to take full advantage of the lower prices in the crypto space and the U.S. equities market. With our liquidity, will take decisive action to ensure strong returns for our fund.
--------------------------------------------------
2022 October 2
Thoughts about the Bank of England and weakness in Credit Suisse
To all readers,
About a week ago, the Truss Ministry unveiled its new budget. In an attempt to stimulate the British economy, the Truss Ministry has resolved to cut taxes on the upper class and to lift the bonus cap on bankers. This is unlikely to succeed. If history is any indication, trickle-down economics are will not be successful in stimulating economic activity, particularly in a global slowdown in economic conditions.
The budget accelerated an already rapid free fall in the exchange rate of the British Pound to the US Dollar. In the past year, the exchange rate for the Stirling is down almost 15%. This announcement also precipitated an extremely rapid collapse in the price of UK bonds. As such, the Bank of England was forced to pivot from quantitative tightening to soft quantitative easing, and began buying back some of its bonds in order to stabilize its prices. To be honest, this is very concerning policy, as the Bank of England is raising interest rates...while running quantitative easing. We have not seen this before, at least to my knowledge. This indicates an extremely unstable financial situation. Given the interconnectedness of the UK economy to the EU and US economies, it is extremely likely that any economic instability in the United Kingdom causes the same effect in the US economy.
This is a potential reflection of what could happen to the US economy later this year/early next year. If quantitative tightening results in an explosive rise in employment, then the Federal Reserve would be forced to pivot. In that case, the asset market could reverse and enter into a brief bull market. However, any such bullishness would be short lived as inflation would remain elevated. We may enter into period of time similar to the 1970s where rates jump up and down as inflation remains out of control. As we saw then, the stock market stagnated and did not grow in any substantial way.
Another piece of news that has been swirling around this week is the potential for the collapse of two major banks, Deutsche and Credit Suisse, which are the 8th and 17th largest banks by amount of assets owned, respectively. Here's a look at credit default swaps for Credit Suisse. As a note, a credit default swap is a financial derivative that allows a buyer to swap their credit risk with another investor. A rise in the price of a credit default swap is typically an indication that investors are becoming increasing worried that an asset may become insolvent in the near future.
As you can see, CDS for Credit Suisse are approaching heights not seen since the 2008 Financial Crisis. This implies that Credit Suisse has taken on extremely risky positions with large amounts of debt. If these banks can no longer pay their debts, they become insolvent and are forced to sell their assets. This triggers a feedback loop where the falling price of assets cause more and more banks to become unable to pay their debts, and so on and so forth. This will cause a collapse of equity prices across the world, similar to when Lehman fell in '08.
Unfortunately, the risks for a crushing recession are becoming more real.
--------------------------------------------------
2022 September 22
The Federal Reserve Raises Rates by 75 Basis Points: Implications and Expectations
To all readers,
At yesterday's FOMC meeting, the United States Federal Reserve raised interest rates by 75 basis points to 3.25%. This is the third 75 basis point in a row. Here, I'll discuss the implications of this hike and the subsequent press conference on the US economy and US equities.
Interest rates are now growing at a faster rate than they ever have before. When the Federal Reserve raises rates, it makes borrowing money more expensive, as the rate an investor has to pay back to the bank is greater than it was before. Therefore, investors are less likely to provide capital in the equities market, and more likely to buy short-term bonds or to put their money in banks. In this way, the Federal Reserve can slow a hyperactive and inflationary economy.
In his press conference following the rate hike, Powell mentioned the likelihood that the Fed would raise rates by 100 to 125 bps. This would imply a 75 bps hike at the next FOMC in November and a 50 bps hike in December. As I've made clear, I believe that aggressive rate hiking is a good thing. We saw in the 70s and early 80s that a failure to get inflation under control caused a stagnation of the stock market. This is not what we want. It is true that rate hikes will cause pain for businesses and investors in the short term, but as Powell himself stated, the pain of failing to get inflation under control is much greater. With aggressive action early against inflation, the Fed can get inflation under control and get the US economy back to a period of long-term growth.
Regardless, investors should be prepared for deteriorating market conditions in the next six to twelve months. The United States IS in a recession, unemployment WILL rise, and equities WILL drop. Now, one question I want to answer is when I expect that the Fed will pivot. I believe that the Fed may pivot when unemployment begins to rise.
The chart shows the US enmployment rate in blue and the inflation rate in orange. As you can see, when the unemployment rate spiked in 2008, the Fed cut rates. Similarly, when the unemployment rate started rising in 2001, the Fed cut rates. Again, when the unemployment rate began rising in the early 1990s, the Fed cut rates. It seems, then, that once unemployment begins to rise, the Fed pivots and begins to cut rates.
There are some indications that unemployment has begun to rise. Companies have begun cutting staff and jobless claims are beginning to rise. The unemployment rate appears to have hit a critical point and may be beginning to rise. However, until there is a sustained rise in unemployment, it is likely that the Fed will not pivot, barring any major things breaking. Pain lies ahead for the US economy, but I believe that a generational buying opportunity will be coming, and I am well positioned to exploit that opportunity.
--------------------------------------------------
2022 September 13
Inflation, Recession, and Equities: A Macro Look at the U.S. Economy
To all readers,
This morning, a new basket of CPI data was released to the public. While headline inflation dropped by from 8.5% in August to 8.3% in September, core inflation (in assets excluding food and energy) was up 0.1% to 6.5%. Inflation will cause deteriorating market conditions for at least six to twelve months. The market is already pricing in further rate hikes from the Federal Reserve, with the Dow down 3.94%, the Nasdaq down 5.57%, and the S&P down 4.32%. Rate hikes are not a bad thing. When the Fed was unable to control inflation in the 1960s, the US stock market became effectively stagnant until the early 1980s. If the Federal Reserve pivots too early, inflation is likely to become entrenched in the US economy. This will inhibit further economic growth. Rate hikes are a good thing!
In the next twelve months, the state of the US economy will remain poor. Unemployment will rise, and prices will remain high. Stocks will remain bearish and are unlikely to set new highs. I believe that a generational buying opportunity is likely to come soon, and I will be there to capitalize with a large amount of fiat.
--------------------------------------------------
2022 September 8
Forward Looking Plans
To all readers,
I wanted to briefly describe what I have done so far as an investor and my future plans for the value of the portfolio.
I began investing in US equities and cryptocurrencies in December 2020 with $3k of saved up allowance allowance money and gifts. Since then, the value of my portfolio has multiplied to ~$7k. I am very aware of the risk that my investments have had, but found the risk-reward ratio to be acceptable.
I am excited to announce my goals for the future of this portfolio. By 2025, I hope to increase the value of my portfolio to $100k. Even further in the future, I hope to increase the value of my personal holdings to $1 million by 2035.
As part of the "$1 million by 2035" plan, I hope to increase the value of my holdings through prudent risk management and asset selection. In the next few months, I will be providing a full in-depth analysis of the current economic situation in the United States, and how they are setting the scene for an accumulation phase of a generation for US equities and assets.
I hope to accumulate as much capital as possible through outside investment, personal income, and borrowed money. This additional capital will place me in the best possible position to capitalize on our position.
I am optimistic that the "$1 million by 2035" plan will be achieved. I am confident in my abilities, and I believe that my investments will provide strong returns in the next decade for myself and any investors.
Google Sites
Report abuse