You Can't Drive By Rear View Mirror
You Can't Drive By Rear View Mirror
Why recession is the next big fear and inflation is the least of our worries.
Everyone "sharp" in my feeds has been calling for this to be the commodity decade. But what if we are already at the height of the commodity cycle? What if things are going to cool off from here, and inflation is going to come down?
The Market's Reaction to CPI
I'm calling it—the market's brief freakout over CPI is over. Since the CPI data came out, I've been writing that I am bullish and that the market is overreacting. The recent market performance suggests I was right. The payroll and unemployment numbers Friday were just the icing on the cake.
Inflation will roll over. It has been too consensus in my feed that inflation will be sticky.
The Correlation Between Oil and Inflation
The price of oil is the price of everything. The blue line in the chart, which oscillates between 0 and 1 (but almost never negative), represents the correlation coefficient between oil prices and inflation.
Do you see what I see? The "inflation" guys got their moment, and now it's time to forget about inflation.
The Fed's Stance
Powell said Wednesday that he thinks the policy rate is "sufficiently restrictive." If we are all honest with ourselves, we know it's true. I recently took out a car loan, and I was shocked at the rate I was charged. It gave me second thoughts. Meanwhile, the price of everyday items is insane. I ordered a coffee and a sandwich today, and it was $31. These are anecdotes, but our experiences reflect the experience of everyone in this country.
What's Next?
My guess is that we will get a few more months of Goldilocks, during which the market will overreact to data in either direction.
Commodities will come down. The recent surge will quiet, but that will not be the true end of the commodity cycle.
It's a matter of time until we enter fiscal dominance, meaning that government spending and borrowing will drive monetary policy. We are running deficits that are too big, and there's very little possibility of that changing. That will have huge ramifications down the line, but the market is not yet ready to grapple with that reality.
Towards the end of the year, I think we are heading for two scenarios:
Recession
Continued Goldilocks
Goldilocks is self-explanatory and just looks like the last 6 months. Stocks go up in a straight line while growth stays strong and inflation continues to slowly moderate. Goldilocks is a great time to own equities.
Recession is more difficult because it has a range of outcomes. You could argue that some form of recession was always going to be the Fed's only way out of the inflation they themselves caused. In fact, I made this argument for most of 2021 when I was quite short equities and crypto.
We may already be seeing the early signs of a recession. Q1 GDP growth was shockingly low at 1.6%. Friday's non-farm payroll numbers were scary in their own way as well.
But the key to me is that the market rallied on Friday. That's because, just as Fed Guy explained, the equities markets will care a lot more about the cuts than they would about a small recession. In fact, a small recession would only be noticed after the fact.
That may sound counterintuitive, but recessions are always decided at least a few months after they’ve begun. A small recession could easily look a lot like “Goldilocks,” with earnings in the Mag 7 holding mostly steady while inflation comes down and the Fed is given cover to ease.
A big recession, on the other hand, is what we have to worry about. I'm not savvy enough to tell you, at this stage, how we should be trying to determine what is coming. All I know is that my instincts are telling me this is what the future is going to look like, and we should start looking closely at the data that comes in with a different question in our minds:
"How bad is it going to get?"
Please also always remember... none of this is financial advice. I’m not a professional. I quite literally don’t know what I’m doing.