Having witnessed the US executive branch try and rebrand the definition of a recession, it has been hard to take a lot of the financial commentary seriously. So I have attempted to lay out for myself where we're at fundamentally in the largest global economy, and what that may mean going into the end of this fiscal year, the mid-terms, and 2023.
The dictionary definition of a recession still remains:
a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
So we have that in our favor and as a baseline for what a recession should look like. The US GDP over the last few quarters empirically shows that the data at the BEA signals that Q1 and Q2 for 2022 were indeed negative. Hence 2022 resulted in a recessionary period.
Looking at the labor force participation rate since the economic downturn in 2020, the US has still not been able to fully replace those workers that left in 2020, and the Fed has admitted that those people and jobs may never come back into the workforce. If those jobs are not there, does that mean that part of the economic growth machine is also missing and if so, will the US economy grow?
With the advancement of technology and in particular the internet, jobs have been disappearing steadily for a couple of decades. The pandemic accelerated this and as an example, the likes of Zoom have removed the need for as many jobs in the travel and tourism industries, as corporate travel drops dramatically. We have also moved more towards shopping/entertainment online, so jobs that would have been in the service industries and retail are just not needed anymore. There may be fewer jobs required to generate more economic growth as technology makes information free and improves productivity.
For those that are still in the workforce, the start of 2022 was a massive financial drag on their personal wealth, as the US government sucked all of the excess money out of their pockets. The 20-period monthly average since 2005 has been, as demonstrated above, steadily rising. With April 2022 sucking all of that excess furlough and savings back out of the economy. During periods of downturn, there are automatic stabilizers such as benefits that kick in, but in an economic upturn, the automatic stabilizers reverse.
This removal of money from the non-government helped bring the stock market down.
From the start of 2022, the S&P500 constituents were mostly trading below their 200-day moving average. When the majority of these companies are struggling to perform it is a canary in the coal mine that all is not well. But if people, companies, and funds have to pay massive tax bills, they will need to also find the cash from their most liquid assets, hence the fall in stocks and crypto especially. In my opinion, the massive tax liability was the catalyst for the steep decline but there have also been market jitters about the Fed's overall monetary policy.
Since late 2021 the Eurodollar yield curve had started to show signs of inversion. The Eurodollar market is one of the world's most liquid markets and is full of the largest funds and investors who look to the Eurodollar market to price future debt. What a healthy curve looks like is a nice gradient leading from the bottom left corner to the upper right corner. Any inversion or dip is a signal that some very knowledgeable people are beginning to see cracks ahead in the financial markets. The current roller coaster of a ride (black line) that is the shape of the Eurodollar yield curve is signaling that there is definitely something to worry about in the future. Market commentators say that the Fed will have to pivot from its current tightening, they also accuse the Fed of having to induce a recession to kill demand and bring down inflation. The Eurodollar market is forward-looking and they either saw the current narrative 8 months ahead of everyone else, or they saw something else.
From my perspective, the Fed didn't induce inflation and therefore they won't bring it down. The breakdown in supply chains due to the pandemic and the fallout and continued disruption around the pandemic was the root cause.
The automatic stabilizers of furlough, benefits, etc. were enough to keep money in the pockets of the people, but more should have been done to keep the wheels of industry turning. In the chart above the massive annual amount of benefits during the pandemic were extraordinary. And this year we are clearly back to some normality. We were a Just In Time economy and any small delay in one part of the supply chain was an inconvenience at best. Shutting everything down was crazy and we will have to wait a long time before we get back to some normality. Where we did see a lack of inventory, we are now seeing excess. If the recession does come, the supply will exceed the demand and we will go into a depression at worst, and suffer from deflation at best, but a deflationary economy is not good in any way. We are also shifting away from relying on other countries to manufacture and supply critical components and products. Donald Trump used MAGA, but Biden has also been forced to consider the major flaw in allowing economic and geopolitical adversaries to control key parts of a supply chain.
The decline in the NFP numbers during the pandemic has been reversed but it took 2 fiscal years to do so. This fiscal year is double pre-pandemic levels and one would hope that continues through 2023. With that in mind, if we were to see the unemployment benefits rising, this would be an indicator that the NFP numbers, however, massaged, should be declining too. My thinking is that if we have people returning to work, that means that there is more money moving about in the system and that is good. When jobs are declining, fear takes over and people save. The credit crunch is always a bad thing. Deleveraging would be the next bad thing.
In 2020/2021 the US government spent over $7trillion on the US economy. This helped push the stock markets to new all-time highs. The current level of spending is already above $5trillion and there are two months left to see if we can hit $6trillion. Looking back to pre-pandemic levels there were signs that the US economic spending was steadily growing, so anything above $5 trillion is good in my estimation.
If it hadn't been for the fiscal surplusses at the start of 2022 and during the spring months, the US annual spending may have been higher. The reduction in spending and increased tax collection again IMHO, was the catalyst for a decline in the stock markets, but now we're seeing economic conditions that are conducive to a market expansion.
Not only is the US government spending, but there is also an increase in loan growth. This signals that the banks also see economic conditions that are not only favorable for them to risk issuing loans but they are also being unshackled from the Reserves placed on them during the period of QE expansion. More loan growth is good for the economy, as is more spending by the government. These two factors should provide a cushion, and "Buying the Dip" is the most obvious strategy.
The question that bothers me, is what is it that the Eurodollar markets are so worried about?
I am not sure where I heard or read this but it stuck with me. Someone uttered that we should sell Oil above $80 and buy it below. It certainly appears that true economic expansion over a long period of time is aided tremendously by cheap energy. With oil peaking earlier in 2022 and now declining, it would suggest that we may also get a boost from the energy markets and a reduction in inflation. Obviously, oil is sensitive to a recession, so if demand is killed, the price of oil will fall precipitously. But cheaper oil will then support the expansion.
My bias is currently leading towards the expansion rather than contraction of the US economy. Therefore I am bullish on the likes of NQ, ES and YM. I would be bearish on CL and I am also bullish on USD, and bearish JPY.
The US is currently a net exporter of oil products, so they are sacrificing cheaper gas at the pump and taking the US dollars back in exchange for the commodity. The US dollar is the global reserve and the world needs dollars. If the USA is removing dollars from the global system that means anyone with USD-denominated debt will be willing to pay higher premiums to get hold of the greenbacks. I currently don't see any other dominant economy or currency taking the global reserve status away from the USA. Buy maybe that is the area in which the Eurodollar market is concerned. Some sort of liquidity event that once again brings the markets to a credit crunch, as we saw in 2008/2009.
Over the course of the next couple of months, I am going to assume that the US is economically expanding and that the stock markets will tend to rise. I want to buy growth and sell a contraction. If the fiscal spending declines into the new 22/23 fiscal year, this would be more bearish. As would more taxation and a budget surplus. I would also adjust if the price of oil were to exponentially rise and the US dollar begin to unexpectedly fall.
I will probably not pay much attention to Fed monetary policy long term, but be willing to step aside should they stop QT or reverse the interest rate hike cycle. Mainly because the market doesn't like uncertainty. I will be paying the most attention to any commentary around a credit crunch, or mass deleveraging.