The Breakdown - 100% Chance of Recession

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, October 19th, and today we are talking about the 100% chance of recession that markets and analysts are now anticipating. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show,

Starting point is 00:00:50 I also work with FTX. All right, folks, well, today we have a ton of news from markets. We are out here getting a sense of how people are feeling, are they optimistic, are they bearish, And we're going to start with something that I think will probably not be at all shocking to listeners of the breakdown. According to new economic projections from Bloomberg, a U.S. recession in the next year is now a certainty. The latest probability models by economist Anna Wong and Eliza Winger forecast a 100% chance of a recession in the U.S. by October next year. That's up from about 65% in previous models. A separate Bloomberg survey of 42 economists predicted the probability of recession within a year at 6,000. 60%, up from 50% a month earlier. According to the Bloomberg model, recession risk is also up on

Starting point is 00:01:38 shorter timeframes. The 11th month risk is at 73%, which is up from 30%, and the 10-month risk is now at 25% up from 0%. The Bloomberg model takes broad-based economic and financial indicators as inputs, some of which have significantly deteriorated over the last month, particularly industrial production metrics. Mohamed El-Ery and the president at Queens College Cambridge writes, 100% probability of a U.S. recession, quite a statement from the Bloomberg economic modeling team. If indeed valid, the implications would extend well beyond the economy, encompassing also financial, political, social, and institutional credibility issues in the U.S. and beyond. Uri and Timmer, the director of global macro at Fidelity writes,

Starting point is 00:02:18 at a drawdown of 28% the stock market is now priced in 85% of a typical bear market, which is negative 33% and 78% of a recession, which is down 35%. Lizanne Saunders, the chief investment strategist that Charles Schwab wrote, CEO confidence fell again in Q422 and is now at lowest since 2007-2009 recession. 98% of CEOs said they were preparing for a U.S. recession. Only 5% reported business conditions were better today than six months ago. Carol Roth, a former investment banker turned author, made fun of the headlines saying,

Starting point is 00:02:50 A Bold Prediction when you're technically in a recession. Now, of course, she is referring to the two consecutive quarters of GDP decline as a definition of recession, but as we've discussed in shows before, it apparently is much more complicated than that. In any case, clues suggest that the Fed thinks recession is coming as well. Bloomberg's lead headline this morning was three words from Fed insiders point to much higher rates. Quote, tucked within 12 dense pages describing the Fed's September policy meeting last week was a statement concerning a seemingly innocuous yet vital estimate that the staff use as a building block for internal economic forecasts. Their gauge of U.S. potential output was, quote,

Starting point is 00:03:27 revised down significantly, the minute showed, due to disappointing productivity growth and slow gains in labor force participation. Explaining this further is Anna Wong, chief U.S. economist at Bloomberg Economics. She said that the policy implication is significant. Quote, lower potential growth means the economy has been more overheated last year and this year than realized, and it will take more rate hikes or a longer period of below-trend growth to close the output gap. Minneapolis Fed President Neil Kashkari reinforced the Fed's hawkish message on Tuesday.

Starting point is 00:03:57 He said basically that there's no way that the Fed can pause tightening even when the benchmark interest rate hits 4.5 to 4.75% if core inflation is still climbing at that time. Quote, core services inflation, which is the stickiest of all, keeps climbing and we keep getting surprised on the upside. If we don't see progress in underlying inflation or core inflation, I don't see why I would advocate stopping at 4.5 or 4.75 or something like that. According to the price of futures contracts, investors are betting on a peak rate of 4.9% next year, frankly, that number just keeps getting revised up. Now, all of this comes after a big surprise to the upside in core inflation growth last month. In September, year-over-year core inflation was up 6.6%, with

Starting point is 00:04:39 month-over-month core inflation at a higher than expected 0.6%. One interesting note from Keshkari's comments is that he diverged somewhat from the party line we've heard on labor issues. The Fed has continuously pointed to a tight labor market as an indicator that it has more room to tighten. Basically, they're saying we need to see less strength in the jobs market to know that our policies are having their intended effect. Keshkari, however, said this inflation didn't come from the labor market. This inflation came from supply chains and energy and commodities. Do we actually have a tight labor market?

Starting point is 00:05:11 One way I would define a tight labor market is, labor is in a relatively strong position, and their share of the pie is growing. Their share of the pie is shrinking, so I don't know. I think probably what Neil is referring to is the fact that although there has been wage growth, it has not kept pace with inflation. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on Nexo Pro. The new Spot and Futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources.

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Starting point is 00:06:31 Circle.com backslash transparency to see why USDC is a trusted stable coin. The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the US. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you train, If you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. What other signals besides just Fed speak might markets be trying to make sense of? Earning season is happening right now and has been seen as a benchmark for getting corporate America's input on where things are headed.

Starting point is 00:07:26 Morgan Stanley analysts led by Michelle Weaver said in a note on Tuesday, quote, This earning season in particular holds importance as it could shape the debate between the Bulls and the Bears. strong results in stable guidance could suggest a more moderate earnings correction or at least push the earnings debate until January's fourth quarter reporting season. However, a sharp production in earnings estimates could signal significant earnings cuts and a potential earnings recession, end quote. So far, Q3 earnings season has presented a soft beat of expectations across the board, which is, of course, much better than the ongoing carnage that some predicted. Even long-term bears like Morgan Stanley's Michael Wilson are seeing the upside in the short term. Wilson has recently called for a short-term rally of up to

Starting point is 00:08:04 13%, while cautioning that this would just be in line with historical bare market rallies. Corporate profits have not collapsed catastrophically so far. Overall profits for S&P 500 companies are on track for 2.2% growth in Q3, with profit growth projected to sit at 5.7% for 2023. Now, this is a significant reduction from 9.7% projections made in 2022, but still represents a healthy growth. That said, Morgan Stanley reported that its research customers still view earnings forecasts for next year remain too high, indicating sentiment that there's could be more downside and earnings compression to come. That didn't stop Netflix from having a bit of a rally yesterday, though. Netflix has had a rough past couple of quarters, actually seeing its

Starting point is 00:08:44 consumer-based shrink for the first time. This week, however, that reversed. The streaming Giants Q3 earnings report released this week showed an additional 2.4 million customers for the quarter, growing in all regions and exceeding internal and Wall Street forecasting. Guidance was issued for an additional 4.5 million users to round out the year. While this growth isn't as robust as previous years, moving on from negative growth in the first two quarters, was definitely a relief for executives and shareholders. As co-founder and chairman, Reid Hastings put it, thank God, were done with shrinking quarters. Shares in Netflix rose as much as 16% in After Hours trading, a relief to the 60% decline the stock has experienced so far this year. The rally in the After Hours

Starting point is 00:09:21 was also broad-based with streaming competitor Roku rallying 4%, and Disney, Warner Brothers, and Paramount moving up more than 2% each. Amazon, Apple, and Meta all also caught the bid rising over 1%. That said, the Netflix report also showed the damage that a strong dollar has done to international revenues. Earnings per share are expected to come in at 36 cents, which is a fraction of the 120 estimated previously by Wall Street analysts. Even after this earnings beat, the company still plans to go ahead with crisis mode revisions to its product, including a half-priced advertising-supported subscription tier and charging for password sharing starting next year. In many ways, Netflix is a reflection of a larger shift that's happening.

Starting point is 00:09:57 We're in the midst of a move from user growth as the key and only metric, back to more traditional business measures like revenue and operating income. This is not something that belongs to Netflix alone, and is even something you're seeing in tech startups as well. Overall, when it comes to stocks, some people are seeing progress in the fundamentals. Steve Dones, the deputy head of investment at Pictette asset management, showed a chart of global price versus earnings since 1988, which shows that PDE has come back in line with where we were pre-COVID, after which there was a huge surge. Steve added, while earnings remain inflated, the great disconnect between equity prices

Starting point is 00:10:31 and earnings has come off a long way. Still, not everyone thinks earnings are all that important, though. Simon Rhee, a former Goldman trader, says earnings right now don't matter. Market doesn't care what you did last quarter. What matters right now is the seismic repricing of money and credit globally, and the impact that's going to have going forward. All I'm saying is earnings are not in the driver's seat. Systemic issues are. Now, whatever the case, the bullishness of the first couple days of this week petered off fairly significantly heading into Wednesday, with the S&P down 0.4% at the time of this recording. Part of that was hawkishness from the Fed like Keshkari's comments, but part of it was also weakness in other areas of the economy. For example, in the housing market, new U.S. home construction

Starting point is 00:11:09 declined last month by 8.1%. Permit applications for single-family home building also dropped to their lowest annualized rate since May 2020. This is definitely the sector that is feeling the Fed rate hikes the most directly. The average U.S. mortgage rates climbed to 6.94% officially, which is their highest number since 2002. Other sources have it above 7%. This 30-year fixed rate has risen now for nine straight weeks, and the Mortgage Bankers' Association's gauge of applications to purchase or refinance a home is down to its lowest level since 1997. Despite this, most analysts don't think the worst is over in housing. Stephen Stanley, the chief economist at Amherst Pierpont Securities LLC, said,

Starting point is 00:11:47 I highly doubt we are near a bottom in housing starts. There is most likely more pain to come. Home builder sentiment has declined every month this year and this month was no different. On top of that, a composite of builder stocks has fallen 35% this year compared to the S&P 500's overall 22 to 28% slump. Of course, the crappy thing about less building happening is that it exacerbates market issues around the price of housing later. Right now, we have a scenario where demand is being hit by rates and supplies being hit by a combination of historic underbuilding over the decade following the global financial crisis, as well as the golden handcuffs of cheap mortgages from the last few years that are disincentivizing people to sell and price themselves into more expensive mortgages. To the extent we see a major decrease in new building, that will continue to create supply constraints

Starting point is 00:12:30 going forward, which of course puts upward pressure on the price of housing. Specific housing markets are seeing it really badly and really acutely. Home sales in California, for example, have plunged by 30% compared to a year ago. The once hot market also appears to have almost completely round-tripped over the past year, with median prices only up 1.6% over the last 12 months. Currently, most homes are being sold below the asking price, and properties are staying on the market for a median of 22 days. which is more than double the selling time from last year.

Starting point is 00:12:59 Jordan Levine, the chief economist for the California Association of Realtors said, high inflationary pressures will keep mortgage rates elevated, which will reduce homebuyers' purchasing power and depress housing affordability in the upcoming year. A pullback in sales and a downward adjustment in home prices are expected in 2023. Last week, the group forecast that the statewide median home price would decline by 8.8% next year. Some of the most expensive markets in California are leading that decline. Santa Barbara County has seen a 9.7% drop, in housing prices in the last 12 months, San Francisco County saw 5.7% fall. Nick Gurley from Reventure

Starting point is 00:13:32 consulting said fastest housing crash markets, 15% drop in sales prices in Oakland, San Jose, and Austin in only five months. That's warp speed for a housing crash. Some of these markets could be down 20 to 30% by year end. And as ever, so the one sector that is actually internalizing these fed rates is seeing just a ton of pain. Now, as ever, there are policies. politics involved in all of these discussions. There are no more official inflation prints before the November elections, which means, among other things, that the Democrats are in spin mode. Democratic Senator for Virginia Mark Warner has said that in retrospect, President Biden's $1.9 trillion pandemic relief package was too big. He stopped short of blaming the package for

Starting point is 00:14:16 spurring inflation, but when he spoke with Bloomberg TV this week, he said, was there too much in the American Rescue Plan on a relative basis? Absolutely. He explained that at the time lawmakers were still concerned about the economy unraveling. But as we've seen, what's happened since is a too strong economy had inflation rise. Republicans, of course, have tried to put a ton of the blame on that March 2021 stimulus package. Warner noted in this interview that pandemic-related relief was much larger under former President Trump, with $2.2 trillion spent in March 2020 and another $900 billion in December. What's more, he doesn't think that these relief packages really had much of an impact on inflation. Instead, he pointed the finger at the Federal Reserve, saying the Fed waited too long

Starting point is 00:14:56 to start this process. Now, in March, economists at the Central Bank of San Francisco wrote that they believe that pandemic relief spending under both presidents had helped push inflation higher in the U.S., but likely had also helped keep the economy from slowing. Finally, Warner expressed that reigning in long-term spending and reducing the deficit would be good policy, citing increasing interest payments on government debt as the catalyst for reform. However, he said that he is not hopeful that they will see bipartisan agreement on this issue. Is there an appetite, he said? I hope so. Is there any movement on that at all? No. Neither party has any credibility on this issue. Now, the responses to this were fairly evenly split down political lines. Brian Riedel, a senior fellow at the Manhattan

Starting point is 00:15:34 Institute, captured Republican sentiment when he said, if only these Democratic lawmakers had been warned that the $1.9 trillion American rescue plan was way too big. Oh wait, they were, loudly, by economists across the spectrum. Meanwhile, Democrats like the anonymous Matt writes, one of the wealthiest members in Congress can STFU. Inflation right now is due to Russia warring affecting energy prices globally, COVID supply chain woes that started under Trump, companies jacking up prices opportunistically because they can get away with it. Now, of course, the damnable thing here is that no one is really wrong, but it's the nature of politics in America right now that you're only allowed to believe one of these sides. When it comes to people going to the polls,

Starting point is 00:16:12 however, I think Ryan Gruber has the right of it when he says, the irony of it is that Democrats spent trillions on things that were individually popular, but have collectively yielded a negative outcome, inflation, whose unpopularity is so powerful that they can't even campaign on the popular discrete components. As ever, we are caught in this cycle of optimism that is then clamped down. It really seems like it happens every week. Can more earnings beats raise spirits of the market? Will the internalization that recession is coming help us price it in so we can get through it? Those are the questions that we will be watching in the days and weeks to come. For now, I want to say thanks again to my sponsors, nexus.com, circle and FTX. And thanks to you guys

Starting point is 00:16:50 for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - 100% Chance of Recession

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