Stagflation leading to Recession - The Kodiak Bear Thesis

[Kevin]

US posted low unemployment numbers which is a great sign of economic growth.

How does it relate to the overhead fears of recession?

One Reddit user provides this comment as insight. Seems interesting.

Comment pasted below:

Look at any chart overlaying unemployment rates vs. recession. Recessions always occur right after a low point in unemployment. Just because we’re hiring now, does not support the idea that future employment will be strong. Basically, a recession is the cause and high unemployment is the effect. You won’t see high unemployment until after the recession has started. I’ll give you a chart straight from Department of labor: https://www.bls.gov/spotlight/2012/recession/

Recessions are predicated on a contracting economy, which usually occurs after strong growth (low unemployment). So just because we’re doing well now, doesn’t mean we wont be in the coming years. This is why the yield curve inverting is such a big deal. It in an indicator of the loss of confidence in the near term growth of the economy. If anything, a low unemployment reading with reduced consumer confidence in my mind suggests companies are hiring based on todays demand and not forecasting the drop in demand coming as prices soar and consumers spend less. If that happens (drop in demand) companies will have to lay off these recent hires and start a cascading effect. I think this is supported by the graph I attached, the unemployment reaches a low trough and then accelerates very quickly upward ultimately creating conditions conducive for a recession.

The readouts from China yesterday showed their economy is contracting. Ours is starting to show signs that it might contract. The EU is about to contract based on massive increases on energy costs in addition to rising inflation. Russia is obviously already in a manufactured recession. It means that we should exercise caution in the coming 18-36 months. It appears this will be a worldwide recession.

[Kevin]

FWIW, it looks like Cathie Wood thinks that the current trajectory is leading to a recession. See her thread here:

https://twitter.com/CathieDWood/status/1510376371712835584

[The_Ni]

Did she carry the argument to its logical conclusion that serves her thesis - that “the Fed is also telegraphing a reduction in rates from 2 years out, so growth will be in vogue again, and thus… hodl because I only invest on a 5-10 yr horizon!”? I tried watching the video but it was too slow and ramble-y =/

Meanwhile, consumer confidence is just plunging. Waiting for the detailed data to be released, but March UMich sentiment survey was at 59.4:

Yet on the supply side… the ISM Manufacturing Index came at 57.1% - lower than in March, but still in expansion mode. (> 50 is manufacturing expansion, < 50 is manufacturing contraction.) This index is quite correlated with the S&P.

And as we know, unemployment went even lower, to 3.6%:

Demand side of the economy is stressed. Yet, supply side still remains buoyant. Just a matter of time though until supply side has to adjust to actual demand destruction, when it happens. Shame really, as the supply side was strong but not overheated, and we could have done a fair bit more of wealth creation on it.

[Kevin]

Your observations align with the comment that I shared here: Stagflation leading to Recession - The Kodiak Bear Thesis - #41 by Kevin

In summary:

• Current demand is strong. Hiring is based on current demands.
• Future demand is likely going to plunge, based on inflation of cost of living (oil, commodities, etc.) outpacing wage growth. This seems to be reflected by consumer confidence plunging at present time.
• Eventually, companies will have to lay off the recent hires to match down to the rate of demand, causing a cascading effect of raising unemployment levels.

[The_Ni]

Thanks @Kevin! Missed reading it the first time.

Found this formulation quite helpful in understanding the sequence in which different parts of the economy will respond.

(Source)

Except this time, instead of a 48 month timeframe, we might be rushing through everything much faster, given how needles are turning.

[Eze123]

Interesting Forbes article from 3/22, a Kellogg Econ professor’s thoughts on why stagflation won’t occur:

Why Stagflation Is Not A Concern, But There Are Other Things To Worry About

The summary I gathered is that he believes monetary policy drives true stagflation, not supply shocks, specifically from the difference in lag in the economy’s response to the Fed’s monetary policy changes. Economic growth and unemployment responds more quickly than inflation (3 vs. 2 yrs), so in previous cases of stagflation they basically increases the Fed funds rate, slowing economic growth and increasing unemployment, during a period where inflation was still increasing from prior monetary expansion. So they all went up at once.

This excerpt caught my eye though:
Assuming the Fed’s policy is sufficient to cause changes in the real economy, it is possible that unemployment will not rise, and economic growth will not fall until late 2023. Inflation will continue to rise after this initial rate rise perhaps until late 2024, if even then, before it starts to decline. This assumes no other intervening economic events that could cause economic growth to fall or inflation to persist, such as the recent oil price shock or the Russia-Ukraine war. Furthermore, a critical question is, will unemployment rise, and economic growth fall enough to cause stagflation?
So I am thinking that whether his theory holds up, comes down to whether the conflict will cause inflation to persist and economic growth to fall enough to force the Fed to have to suddenly relax the rates again. Though he does state doubts on whether such small rate hikes will have any effect.

Curious of others’ thoughts, I definitely agree with many of the bearish points in this threads. But this, alongside the recent relief rally, makes me wonder if we don’t have another short period of growth before we feel the effects of monetary policy shifts.

[bigglyoptionoligist]

Putting this here, but general sentiment of slow down by JPMorgan

A recession in the near-term is possible, but not probable. Here’s why.

[Kevin]

Interesting. The article makes an overview case for recession and then goes into further detail against recession.

Here are my sparknotes of the JPM article:

[size=4]Notes[/size]
For Recession:

• No notes here as their single paragraph argument is quite concise. Just read it:

Consumer sentiment is horrible, especially expectations for their future situation. Russia’s war in Ukraine is adding uncertainty and causing commodity prices to spike. Mortgage rates have seen their biggest six-month surge in 50 years, causing housing affordability to plummet. At some point, those calling for recession argue that the consumer has to crack. In Europe, the proximity to the Russian war in Ukraine as well as reliance on Russian oil and natural gas increases near term recession risks. Slower growth in Europe would surely impact the United States.

Against Recession:

1. Signs of softening in supply chains and semiconductors, including increased inventory growth and reduced backlog of ships. This could mean weaker goods prices later, which is good for reducing inflation.

2. Both businesses and consumers across the US have healthy balance sheets.

3. Corporate profit margins are a key piece of evidence against recession. Today, despite surging input and labor costs, after-tax profit margins are at all-time highs. This suggests that businesses have little incentive to reduce costs and lay-off workers. If margins do start to decline, the clock could be ticking faster toward recession.

4. U.S. job openings rate, which is a measure of labor demand, is at all-time highs and still climbing.

JPM believes growth will slow, but not enter a recession.

[size=4]Some Commentary[/size]
Notes #3 and #4 are possibly countered by the argument that demand will plunge based on consumer sentiment at lows and inflation and cost of living rocketing.

• For #3, as discussed in earlier comments on this thread, if demand wanes in the future, this could lead to lay-offs of workers to match the reduced demand.

• For #4, as discussed in earlier comments on this thread, it is possible that the current labour market is based on current demands, and is not factoring in reduced future demands. If this is true, then the current strength of the labour market may be a red herring.

We’ve seen so much discussion both for and against now. I’m not sure what to think. Who will be right? Either way I still think the S&P has room to fall in the near future.

[bigglyoptionoligist]

Thanks Kevin! I agree with you, I am indecisive on this overall. Great points raised by you guys on the yield curve, etc. Feel that a pull back is warranted, and longer term penny pinching is on the horizon.

I think we are also heading into a sentimental overspend phase in the coming weeks and months where people in the US will be able to enjoy more of the seasonal things that were previously being restricted by COVID. Thereby creating the mantra of “hey my family hasn’t been able to do this since 2019!”, attitude, even if the cost for whatever they were doing is higher.

Putting this here for consumer credit data releasing April 7

United States Consumer Credit Change

I am still bear given the high speed race back to pre COVID highs, but not putting my full conviction into plays in the interim.

[Kevin]

Don’t know where to else to share this but I enjoyed this comment.

Particularly this bit:

You really have to think of the market as forgetful, delayed reaction kid that is easily excitable when he/she sees candy, and fearful when he remembers he forgot to do his homework. Not some kind of omnipotent, supercomputing, “everything-priced-in” entity.

[The_Ni]

Probably exasperated that the stock market had mostly ignored JPow’s prognostications and promptly executed a BTFD-fueled rally like the good old days, the Fed sent Brainard, one of its more dovish governors and seen as Powell’s #2, to strike fear in the hearts of those who cannot let go of their inner bull.

Between talk of balance sheet reduction at a “rapid pace” and a reminder of aggressive rate cuts, it seems to have done the trick. The 2Y-10Y came to its senses and un-inverted, and 30-year fixed mortgage rates climbed over 5%. The market also shed some percentage points to boot.

The change in words used for balance sheet reduction is important. We went from JPow saying “meh we’ll let the assets roll off the balance sheet as they mature” to Brainard saying “we will reduce the balance sheet at a rapid pace.” The markets therefore responded by sending yields higher, anticipating a release of long duration bonds … and even the 30yr MBS that is also a good chunk of the Fed’s balance sheet.

If a 5% fixed 30-yr mortgage rate persists, difficult to see how the housing market does not take a hit, as most folks gauge affordability by the size of the monthly installments. Corporations that are riding fast and loose on near-free debt should also start sweating soon as long durations curl up.

So… who do we short when the housing market slumps?

[macromicrodick]

I’ve been trading puts on RKT but TREE is also a direct competitor. I chose RKT because they it tends to not move as high with SPY but decreases faster when SPY falters. It’s been a battered ticker and derives most of its profits from refinancing mortgages which has been a struggling part of its operations since February.

[TheHouse]

If you remember last FOMC meeting, the descision was made for a 25bp hike, it was what the market was expecting and J Pow had a press conference after and had a very calm dovish tone. it wasn’t until a few days later that J Pow as well as all fomc members change thier tone to more hawkish.
The minutes from that FOMC meeting get released today. Although we dont get a full transcript, (we dont have access to that for 10 years) I believe we will see how concerned they were with inflation. I think the comment that were made yesterday regarding an accelerated taper was a strategic way to prep the market for alot of the same tone released in the minutes today.
This is important because the price action yesterday was imo the first real dramatic signal from the equities market this year solely based on monetary policy alone. (Without the russia situation)
At the very least im watching volatility today, but there is a real chance if we dont have a short term bull catalyst we see real capitulation with equities.

Hope everyone has a great day.

Current port
IWM 4/14. 200p
QQQ 4/14. 355p
SPY 4/14. 443p
HYG 4/14. 81p
SPY 4/8. 453p
ARKK 4/8. 68p
AXP 4/8. 182.5p
LAC 4/14. 42.5c

[TheHouse]

Had a decent day. Cut most of my 4/8 positions today:
APX - +219%
ARKK - +346%
SPY- +664%
LAC- -84%

We have fresh CPI numbers next Tuesday, so im going to keep that in mind the next 3 trading days.

Current positions:
SPY (5) 4/8. 440p (This was a mistake)
SPY (2) 4/14. 443p
IWM (12) 4/14 200p
QQQ (4) 4/14. 355p
HYG (25) 4/14. 81p
HYG (38) 5/20. 75p
BEEM (5) 4/14. 25c
VIX (6) 4/20. 35c

[Momstock]

I’m late, but thank you for the write up while navigating grief. Much appreciation!

[Kevin]

Fantastic share by @Apostle in the ZIM thread about weakening average consumer income, which strengthens the theory of upcoming weakening quarterly ERs. Reduced forward guidance on ERs would likely hurt the market a bit further.

$ZIM - Playing spot exposure of containerships

Really great insight, I was looking for a person I was reading about around this time last year. She had really good points on our logistics supplies back log and the housing market, ultimately moving into a deflationary environment. She recently shared some tweets that speak to your points about lower global aggregate demand. With China in contraction, I believe the rest of the globe will follow. [Capturetwitt] [capturedi] [capturedi2]

[TheHouse]

Interesting day. Cut some positions at the double bottom around SPY 443, mainly my ITM puts. I was feeling good about re positioning when SPY hit resistance of 446. Cut my ITM for slightly OTM. Market continued to run and unfortunately ran into PDT limitations that made me hold on longer than I wanted. My mistake for sure.

Expecting a red day tomorrow, but if it goes green I will cut positions and look for better entries.

[Kevin]

Really did not see that 10 AM PST rally coming. Looking back at the last several trading days there seemed to be kind of retard strength rally at around the same time of day every day. Very very strange.

Hoping for a bloody morning to close my puts, and will watch out for the rally before repositioning 04/14s.

[Kevin]

Deutsche Bank says:

• Recession in '23
• Stocks to fall 20% by summer '23
• Unemployment to 4.9% in '24
• 10yr yields to hit 3.3% this year

https://twitter.com/daniburgz/status/1511638230013259785

Copy and paste of the Bloomberg article:

The U.S. will tumble into a recession next year as the Federal Reserve jacks up interest rates to combat high and widening inflation, Deutsche Bank economists David Folkerts-Landau and Peter Hooper said in a report on Tuesday.

They see the Fed raising rates by 50 basis points at each of its next three meetings on its way to a peak above 3.5% by the middle of next year. The Fed’s current target for the federal funds rate is 0.25% to 0.5%, after it lifted off levels near zero last month.

Deutsche Bank is one of the first major banks to forecast a U.S. recession. Goldman Sachs Group Inc. economists led by Jan Hatzius said in a report on Monday that an economic downturn was “far from inevitable,” in part because consumers and companies are “flush” with cash.

“Our call for a recession in the U.S. next year is currently way out of consensus,” Folkerts-Landau and Hooper acknowledged in their report, adding, “We expect it will not be so for long.”

On top of the Fed rate increases, Deutsche forecasts the U.S. central bank will reduce its $8.9 trillion balance sheet by almost $2 trillion by the end of next year, the equivalent of three or four additional twenty-five basis point hikes.

“The U.S. economy is expected to take a major hit from the extra Fed tightening by late next year and early 2024,” Folkerts-Landau and Hooper wrote in a report entitled “Over the Brink.”

Under the forecast, U.S unemployment rises sharply to 4.9% in 2024. Joblessness in March clocked in at 3.6%.

The yield on the 10-year Treasury note is seen climbing to 3.3% this year while stocks suffer a “transitory decline on the order of 20%” by the summer of 2023 as the recession takes hold.

Folkerts-Landau is group chief economist. Former Fed official Hooper is global head of economic research.

While Deutsche Bank is among the first major banks to predict a recession, many finance professionals are coming to the view that a downturn is likely as the Fed tightens credit, according to a recent survey by Bloomberg.

Looks like there’s a lot more detail in this article/interview released today: Fed will tip U.S. economy ‘into a recession by the end of next year’: Deutsche Bank economist

Despite the bearish fuddy headline, DB is still bullish for 2022. They are “pretty optimistic or constructive on the economy this year. We think consumer spending has good momentum, business investment has good momentum, household balance sheets look in great shape. Obviously, the labor market has a lot of momentum.”

However: “fundamentally, the economy is very far away from the Fed’s targets-- that getting back to those targets requires restrictive policy.”

[Apostle]

Thanks @Kevin ,@TheHouse , and @The_Ni for all the work you have been putting in lately in the community. I think I may have stumbled onto possible a play scenario. Essentially the other day someone in TF was talking about UPS going to kill earnings and FedEx going to flop. Today someone posted about Walmart paying good money to get new truckers into their fleet. This got me thinking bullish about logistics and shipping, then I realized I need to always do opposite of my emotion as I make more money this way.

I started thinking more about the stagflation- recession- and deflation topics going on in this thread. I feel All the forces we have been speaking about above has really put the writing on the wall and As Thots says Valhalla is always early.

Since Covid the trucking and logistic industry has been on fire, new companies are popping up left and right to meet the demand just in time to be left holding the bag. In my random deep dives of twitter and Reddit I found an analyst who believes the trucking and logistics sector is soon to get crushed and it’s going under reported.

Why I believe a freight recession is imminent

https://seekingalpha.com/news/3820435-trucking-stocks-trade-like-a-freight-recession-is-already-here

Do you think it’s too late for some PUT plays on freight? There has been some drop from COVID highs but I feel there is a lot more to go.