By Richard Morey
Out of the frying pan…
WHAT GOES UP:
Inflation began to pick up in April of 2021 and hasn’t looked back, rising from under 4% to over 8% in one year. The numbers coming out for June are supposed to be the worst we’ve seen – in the range of 8.7-8.9% year-over-year growth in the Consumer Price Index.
We now, however, believe inflation will soon be a thing of the past. This is due to something called “demand destruction.” When the Fed began contemplating raising interest rates above zero a few months ago, most analysts mentioned the only way raising rates would slow inflation would be to make it so difficult on consumers they would stop spending money. This is called demand destruction. It’s now happening – big and fast.
Semiconductors are the “leading” leading economic indicator, as chips are ordered in advance and used in so many goods. Their stocks are down 40% year-to-date and the CEOs of the two industry leaders Intel and Micron say their poor performance of late is due to dropping demand. This means dropping demand for everything. I heard another CEO whose product is used in kitchens around the world say yesterday (6/5) demand in every country except India is down roughly 15% year-over-year and dropping fast. He says we’re clearly now in a recession.
When consumers have to cut back on spending, businesses cut back in anticipation. This can be seen in the fact investment growth in businesses (real gross private domestic investment) cratered 15.2% in the last quarter. (Atlanta Federal Reserve Board.)
All the world’s central bankers are raising interest rates to slow inflation and, in the process, pushing their economies directly into recession. For once the Fed is free of blame – due only to the fact they have no choice and no way out. They have to raise rates or inflation will ravage the economy. But as they raise rates, the economy plunges into contraction.
Analysts from the Wall Street investment banks are saying there might now be a 35% chance of a recession next year. What a joke! According to a recent poll conducted June 24-26 of 2,581 adults by Civic Science, 71% of us believe we’ll be in recession by the end of this year while 35% believe we’re already in one.
For some reason all the so-called experts are ignoring the fact the economy contracted in the first quarter (-1.5%) and, according to the Atlanta Fed’s GDPNow, contracted sharply in the second quarter at -2.1%. (In other words, expect the final, official start of this recession to end up being January 1 of this year.)
Instead of recognizing the actual numbers showing us already in recession, all the talk in the financial media is split between two camps. One camp says we may actually avoid a recession altogether while the opposing camp talks about how mild the coming recession will be. This fierce debate as to whether we’ll have a recession – next year – and just how mild it will be, is occurring in an economy which, if the Atlanta Fed is correct, contracted 3.6% in the first half of the year. This level of contraction has never occurred outside a severe recession. And the one thing they all agree on is that the first six months was the easy half of the year!
It’s almost as if they don’t want to see what’s occurring? Perhaps it has something to do with the fact we haven’t even seen fear elevated yet in the stock market. The moment the investing public figures out where the economy is, and where it’s headed, they will finally start to sell their S&P 500 index funds in fear. This will coincide with a plunge in financial media ad revenues. Until then, the financial media assures everyone, over and over, not to worry. The Fed has everything under control, and Chairman Powell says he can raise rates to stop inflation without any type of recession. If not, a mild recession sometime in the future. That doesn’t sound too bad, does it? Certainly worth a little risk in case stocks are going to take off again, right? Of course, you know my answers.
On the corporate debt front, the spread or interest rate junk bonds are now paying above high quality bonds recently spiked up to its highest level since June of 2020. When it hits March of 2020 levels our historically large edifice of rotten corporate debt will spark losses which will then lead directly into the real world of bankruptcy proceedings for many of the hopelessly indebted companies.
If the 71% of the public which agrees with me and already sees what the Atlanta Fed numbers are showing us turns out to be correct, the implications are huge for portfolios. What it means is that they need to flip from inflation protection to protecting against the opposite known as severe economic contraction – lower prices and indeed lower everything except managed futures and bond prices.
It means lower interest rates, higher bond prices, and the end of any thought of an extended bull market for commodities. Even wheat prices are down 24% from their 2022 highs – when a major amount of the world’s wheat is being kept off the market. Oil prices have also gone back below $100 a barrel – again due to dropping demand. That’s the power of a contracting economy to snuff out inflation and, with it, commodity prices.
The Fed will almost certainly raise interest rates one more time – another .75% this month. From what we’ve seen thus far in 2022, this should be more than enough to settle any remaining questions as to whether or not we’re either in a recession already or entering one in the second half of the year.