Dec 11, 2022·edited Dec 11, 2022Liked by Alfonso Peccatiello (Alf)
this seems very much to be the case.
everyone is bearish, but everyone is long. they think the bottom is near, which is why the bottom is not. bottoms are made in fear, not in ennui. portfolios (esp in big cap tech) reflect a lack of understanding of what "recession" means. (meanwhile, a lot of microcap is down 70-90% and trading deeply cheap)
i suspect we see that space pop as tax loss selling ends and that next year will be a pain tolerance test for big cap tech until it breaks and ends in rout. the big, bellwether names have massive downside still and therefore so do the indexes. 2023 going to be a rotten year there, but a good one for smaller cap stockpickers.
A friend based in Switzerland working in finance with American millionaires for clients told me the other day that the recession is already priced in and the best option is sticking your money in an index ETF as the stock market always go up...
You assume a 20% EPS drop - is there further justification why this recession will be the shallowest for 40 years (based on your table, although that includes some unique circumstances)?
Earnings have risen on the back of recent stimulus spending. Non-financial corporates are more leveraged than 15 years ago and with a recession coming, they are probably just getting started. Housing has been roaring away for a couple of years and the job market looks less robust than at this stage in the past.
Would a 40% drop be surprising or inconsistent with where we are starting from?
What drop would be implausible - i.e. what is a credible range?
One question on signals from the bond market: have you ever explored the correlation between yield curve inversion, recessions, and earnings drawdowns? Meaning, does deeper yield curve inversions (whether we're talking 10-yr/2-yr or 10-yr/3-mo Treasury curves) correlate to either more severe recessions and a corresponding corporate earnings decline?
I'm curious on your thoughts on that area of the bond market, and the implications for the type of recession/earnings decline. Thanks!
This is the most anticipated recession ever. What is so puzzling is how orderly declines have been in both stock and bond markets. As an aside I find symmetry between your view and Felix Zulauf (one of his few interviews). He sees a roller-coaster decade but the chance for growth to shine, though perhaps briefly, when those rate cuts finally occur. However, for a generation, the easy money has probably been made.
150bps of cuts would take us from what the fed sees as an restrictive, inflation combating rate at c.5% to 3.5%, which would be consistent with PCE between 2.5% and 4% based on the long run reaction function. To me that's a normalisation rather than definitely pricing in a recession (where policy would likely get easier than 'normal')
Here's the bigger question....one that you likely don't have the data to answer but would be a telltale for where we're going in 2023.
The yield curve is DEEPLY negative, and a negative YC has been a 100% telltale to a 'proper recession' ahead. Where were your probabilities priced-in before each of these recessions compared to our <20% probability today? My bet is that it was significantly higher, and that the 'smart money' bond market had it right well ahead of the lagging stock market indices. KB
Investing is about thought control & your own ego more than anything else..or so I believe. You seek out those who share your own self-reinforcing opinions (I'm with you, Alf, on a big recession starting in 2023) but I'm also mindful to read opposing opinions in case we're wrong. However, this latest newsletter is probably the best thing I've read so far in support of the 'prosecution' case. I've not read anything compelling from the 'defense' side other than the usual hope & pray stuff. On a lighter note, I was going to offer you, @Alf, my consolations, as an Englishman, for the Dutch football loss. I then remembered that your birth country is Italy....
I think your estimates are very conservative given the amount of debt in the public and private sector. Unless fed pivots. However even that may not have a sustaining effect when it happens.
what happens if a fed forced pivot in less than 6 months causes us dollar down hard, commodities up hard, inflation returning, and bond yields up? Do we have a renewed recession?
I guess you are looking at the BS delta of the 3200 strike to approximate the probability of SnP trading below that level in 1 year. I would add that the implied probability of it touching that level at any point in that period should be 2* delta so around 32%
this seems very much to be the case.
everyone is bearish, but everyone is long. they think the bottom is near, which is why the bottom is not. bottoms are made in fear, not in ennui. portfolios (esp in big cap tech) reflect a lack of understanding of what "recession" means. (meanwhile, a lot of microcap is down 70-90% and trading deeply cheap)
i suspect we see that space pop as tax loss selling ends and that next year will be a pain tolerance test for big cap tech until it breaks and ends in rout. the big, bellwether names have massive downside still and therefore so do the indexes. 2023 going to be a rotten year there, but a good one for smaller cap stockpickers.
Great article, many thanks.
A friend based in Switzerland working in finance with American millionaires for clients told me the other day that the recession is already priced in and the best option is sticking your money in an index ETF as the stock market always go up...
He's obviously not a reader of the Macro Compass!
Thanks for another great article, Alf.
You assume a 20% EPS drop - is there further justification why this recession will be the shallowest for 40 years (based on your table, although that includes some unique circumstances)?
Earnings have risen on the back of recent stimulus spending. Non-financial corporates are more leveraged than 15 years ago and with a recession coming, they are probably just getting started. Housing has been roaring away for a couple of years and the job market looks less robust than at this stage in the past.
Would a 40% drop be surprising or inconsistent with where we are starting from?
What drop would be implausible - i.e. what is a credible range?
Thanks for this great article.
Great post and analysis!
One question on signals from the bond market: have you ever explored the correlation between yield curve inversion, recessions, and earnings drawdowns? Meaning, does deeper yield curve inversions (whether we're talking 10-yr/2-yr or 10-yr/3-mo Treasury curves) correlate to either more severe recessions and a corresponding corporate earnings decline?
I'm curious on your thoughts on that area of the bond market, and the implications for the type of recession/earnings decline. Thanks!
Thank you Alf!
This is the most anticipated recession ever. What is so puzzling is how orderly declines have been in both stock and bond markets. As an aside I find symmetry between your view and Felix Zulauf (one of his few interviews). He sees a roller-coaster decade but the chance for growth to shine, though perhaps briefly, when those rate cuts finally occur. However, for a generation, the easy money has probably been made.
150bps of cuts would take us from what the fed sees as an restrictive, inflation combating rate at c.5% to 3.5%, which would be consistent with PCE between 2.5% and 4% based on the long run reaction function. To me that's a normalisation rather than definitely pricing in a recession (where policy would likely get easier than 'normal')
Thanks Alf, always love your post and looking forward to the new year, subscribed!
Here's the bigger question....one that you likely don't have the data to answer but would be a telltale for where we're going in 2023.
The yield curve is DEEPLY negative, and a negative YC has been a 100% telltale to a 'proper recession' ahead. Where were your probabilities priced-in before each of these recessions compared to our <20% probability today? My bet is that it was significantly higher, and that the 'smart money' bond market had it right well ahead of the lagging stock market indices. KB
Investing is about thought control & your own ego more than anything else..or so I believe. You seek out those who share your own self-reinforcing opinions (I'm with you, Alf, on a big recession starting in 2023) but I'm also mindful to read opposing opinions in case we're wrong. However, this latest newsletter is probably the best thing I've read so far in support of the 'prosecution' case. I've not read anything compelling from the 'defense' side other than the usual hope & pray stuff. On a lighter note, I was going to offer you, @Alf, my consolations, as an Englishman, for the Dutch football loss. I then remembered that your birth country is Italy....
I think your estimates are very conservative given the amount of debt in the public and private sector. Unless fed pivots. However even that may not have a sustaining effect when it happens.
what happens if a fed forced pivot in less than 6 months causes us dollar down hard, commodities up hard, inflation returning, and bond yields up? Do we have a renewed recession?
I would imagine its only "fully priced in" when the stock market bottoms (?)
What does "a macro portfolio construction that benefits from these relative mispricings" mean exactly?
I guess you are looking at the BS delta of the 3200 strike to approximate the probability of SnP trading below that level in 1 year. I would add that the implied probability of it touching that level at any point in that period should be 2* delta so around 32%