Oil Crisis. Inflation. America pulling troops out of a foreign country. When we read these headlines, our minds immediately go to the many events of the past 5 years. In reality, these same (or spookily similar) events occurred in the 70’s. Jeff was born in 1970 so does not have a great memory of the first time these events occurred whereas Biff is slightly older and remembers car lines for gas, high double-digit mortgage (and bond) rates and national dissension around Vietnam, but the recent recurrences are forever burned into our minds’ eyes now. As George Santayana wrote in The Life of Reason (1905), “Those who cannot remember the past are condemned to repeat it.” History tends to repeat itself in economies and markets as well. However, we are also mindful of the saying, “this too shall pass.”
The global economy is in the midst of its first true termination of a business cycle — aka the dreaded “R” word Recession — since the Federal Reserve (the Fed) started tinkering around the turn of this century with interest rates, quantitative easing and helicopter money. These tools of modern monetary policy, often referred to as “the Fed (or Powell or Yellen) Put,” resulted in markets thriving on excess global liquidity with very little real recession risk. However, this Elysian moment appears to be coming to a bad end as an economic reality called Inflation is hammering the globe caused by excess demand from $1.4 trillion (yes, the “T” word trillion) in savings accumulated by Americans tired of being locked up in their homes, insufficient bodies ready and willing to work all the open jobs, and constricted supply of commodities, energy and other goods as a result of the Ukraine conflict, deglobalization, and energy and trade policy missteps. The Fed is working hard to put the genie back in the bottle and regain the Market’s confidence, a difficult if not impossible task, while the Administration and Congress are frittering away time and money with politics.
In its role as a giant discounting mechanism, the Markets started priced in the probability of Recession about 5 months ago despite many Wall Street forecasters unwillingness to call this a Recession. As of this morning, Wall Street is finally getting behind the fact that we are in a recession as a direct result of Friday’s hottest ever inflation rate and the growing conviction that the Fed will need to step on the gas in terms of raising rates thereby causing a recession. But, as we averred a month ago, we believe this may be a different kind of Recession than the 1970s mainly because we do not expect the usual unemployment. We do expect massive hiring freezes though. Indeed, there have been recent reports of work force reductions (remember “RIFs”?) in some of the newer technology companies like Coinbase, Robinhood, Carbon Health, and Carvana, and even Tesla has announced a halt in hiring. Still, we most likely will not see old school companies with large layoffs due to the exceptionally tight labor market and as expected Fed re-engagement in some form of stimulus in the next 6 –12 months. Not to be outdone, we are also expecting deflation to return and the 10-year treasury to retreat to 1%. This will not happen overnight, but treasuries will start to trend in that direction. We do not believe this will be led by a collapse in housing prices a la the Great Financial Crisis in 2008/2009, but we do expect a sudden halt in the growth for housing over the near term.
So, the Recession we see is one with lower housing demand and lower sales and margins (ref. Netflix slashing guidance, Microsoft’s warning last week, mounting fears that Apple’s iTunes store is losing momentum, and Target’s twice-in-2-weeks profit warnings due to excess inventory) with the near-term exception of travel-related consumer discretionary companies. High oil prices -- up about 100% over the past 12 months -- should continue until the run on vacations (termed by some “revenge travel”) abates and accumulated savings are consumed.
As an aside, Jeff and Lynn just returned from their first European vacation since 2019 and the crowds there are out in full force. Biff and Sonya just arrived from a conference in Southern California where the real estate magnates were packed in the hotel like sardines, airfares are triple-digits, and Delta was offering $600 vouchers to reduce overbookings.
The key here is that most of the leisure travel was booked months ago when energy prices were low and inflation latent, hence we expect travel demand and spending to slow. High prices, as the saying goes, correct high prices, and airfares are already falling as travelers balk.
Where do we land this plane, then? Now is not a time for fear. The Markets have largely priced in this high employment recession and a market bottom is not too far off. Higher market volatility will extend through June and into July. Relief in the markets will come once the Street agrees the global economy is slowing, recession has come, and the Fed reacts. Repriced risk assets then become “safe” or at least investible again. We offer one very large caveat here, that we do not see lower gas and oil prices for at least 2 years and potentially stretching longer. Sadly, we think $5 gas is her to stay (in Virginia at least, and much higher in California).
With this in mind, we continue to slowly and gradually redeploy hoarded cash back into the Markets via systematic monthly investment into one of our long-term growth managers and other opportunities. We maintain our current commodity and dividend strategy which has provided positive and less negative returns respectively during 2022. We continue to favor private commercial real estate, private credit and private equity/early stage venture investments for cash flow, reduced volatility and long-term accrual of value. We are even warming up to US Treasuries for price appreciation in recessionary times. Most important of all, we are in no hurry. With cash in the bank, dividend yield from our market investments, and cash flow from our private holdings, we can wait for our main thesis to play out and tweak our plans as needed as additional data points present themselves.
As always, we are delighted to speak with you anytime. Call, email or text us. And have a lovely Summer in the knowledge that we are, to the best of our experience and abilities, looking out for your financial wellbeing.
Warmest regards,
Jeff & Biff
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