The Associate's Recession

Cuffing season's coming late this year. With less than 48 hours until the next CPI report, it looks like even Jamie Dimon is beginning to stress about the client spend he'll have left by the end of this quarter. So let's dive into the upcoming inflation report and Fed minutes, as well as the impact they're already having on markets.

Bottom Line Up Front

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• Cathie Wood wrote an open letter to the Fed accusing it of stoking "deflation" and looking at the wrong economic indicators. The current CIO of ARK Invest may not be the best at telling when the music has stopped, though, given she was rejected twice from USC's marching band.

• JPMorgan says a too-hot CPI would put stocks at risk of slipping ~5%. To be fair to CEO Jamie Dimon, he's probably still upset about paying NYC taxes when he was about to move to Seattle to work at Amazon. The rationale: his love for "Sleepless in Seattle," which led him to want to get a houseboat and never put a suit on again.

• TikTok is chasing Amazon with plans for U.S. fulfillment centers. It's a sharp contract from parent company, ByteDance's, culture of nap-taking everyday from 1-2 PM. In warehouse fashion, though, they just sleep on their desks.

But first, a quick note from The BAD Investment Company.

Tired of ESG Bullsh*t? Fortunately, there's a money manager that decided that B-A-D might be the better acronym for investors.The BAD ETF (NYSE: BAD) launched last December and is taking a different stance in this green washed world focusing on 3 industries for which the ticker represents – B-A-D.

• Betting – Casinos, gaming, and online gaming operations – 33%

• Alcohol – Alcoholic beverage manufacturing and distribution – 23%

• Drugs – Pharmaceutical and biotechnology product development and manufacturing – 33%Cannabis cultivators & distributors - 10% 

The case for these BAD industries remains strong for a simple yet important reason – they have historically offered attractive risk-adjusted returns. In addition to these industries overcoming government scrutiny, these industries have shown resilience during economic downturns because people tend to indulge in their vices, or what some call hobbies.

As a result, we believe these asset classes are typically underappreciated and therefore under-valued but the reality is that people will continue to consume alcohol, gamble, and need medicine in good times, and in BAD.

In regards to the betting and cannabis aspects, as these industries become more widely accepted socially and legally, they may offer investors additional growth as more states look to legalize those industries for additional tax revenues.

Learn more about the BAD ETF fund details and sign up for our mailing list to get the latest fund insights and information.

Deep Dive: Dr. Doom feat. Jamie Dimon

J Pow finally won his war.

We don’t mean the fight against inflation, which has been front page news for months now. That battle has certainly been on Powell’s mind; but behind the scenes, a different war has been raging since the bull market’s slippage. This one is between the Federal Reserve and Wall Street.

A growing number of economists believe the Fed's landing will be nothing but hard. Nouriel Roubini, for example, is one of the economists who predicted the 2008 financial crisis, earning him the title of "Dr. Doom." And now, he sees the markets falling even further. Dr. Doom, paired with Jamie Dimon's comments yesterday that we'll soon tip into a recession, are only two in the camp that's filling with bears.

It has been the battle to convince the daily market movers that Jerome Powell is Paul Volcker but in 2022 HD. This isn’t the most original comparison by now, but in case you missed it, Volcker is that Fed chair who crushed post-Vietnam War inflation by boosting interest rates well into double digits. He then sent the nation into a deep recession. Today, trillions of dollars and Powell’s legacy are on the line.

For decades now, traders and investors alike have come to rely on the Fed to step in and make sure that stock market downturns, when they happen, do not get out of hand. This intervention originated from Alan Greenspan’s appointment as Fed chair in 1987. He turned the Fed and general public onto the “wealth effect,” which suggests that the Fed should step in should stock market declines hit the ~20% threshold. That meant reducing interest rates and pumping money into the system.

In other words, Greenspan re-branded trickle-down economics as the “Greenspan Put.” The term that encapsulated the belief on Wall Street that the Fed would step in to stem market losses. (For traders on Tik Tok: a “put” option is a type of investment product that can insulate from a drop in stock price).

The coming generations of Fed chairs used Greenspan’s interventionist playbook and his Put became the “Fed Put.” When he was faced with deepening market turmoil in 2020, Powell drew from the playbook to use all the tools at the Fed’s disposal to keep money flowing through the economy.

Not Your Father’s Fed

To be fair to him, it largely worked. In the wake of a 30% decline in the S&P 500 from mid-February to early-March 2020, the Fed moved aggressively to stabilize the financial markets. By the end of May, the stock market declines had largely been reversed, and even as Covid-19 shutdowns wrecked havoc across the economy, the flood of liquidity pumped into the system by the Fed marked the beginning of a new bull market. Bond and stock markets alike soared to new historic highs.

But those expectations of intervention set the stage for the struggle we’ve now watched play out between Powell and Wall Street this past year. Powell pivoted to the iron fist playbook of Paul Volcker. As much as he insisted that the era of the Fed Put was over, stock and bond traders did not buy it. Instead, they took Fed interest rate hikes this year in stride. Most times a member of the Fed went public to insist that they were serious about pushing up interest rates to tackle inflation, a day or two of market losses were inevitably followed by market rallies. Traders remained confident that when the time came, the Fed would reverse course and bring interest rates back down.

After a battle that continued back and forth for most of the year, Powell finally prevailed two weeks ago. With the Fed’s latest three-quarters of a point hike in interest rates, and continued quantitative tightening (Fed-speak for selling long-term bonds to force long-term interest rates higher) pushing mortgage rates to the highest level since before the 2008 financial collapse, traders threw in the towel. Bond and equity markets tumbled, and market indicators turned broadly negative, suggesting a widespread expectation that the economy will experience a recession of some duration, and that the Fed will not pivot to bring interest rates back down until 2024 at the earliest.

What Now

The S&P 500 is down 5 of the last 6 weeks, -14.2% off of mid-August highs and re-testing the mid-June low. This could be a natural spot for a bounce. In order to get to June-level capitulation, you would need all of the following:

• SPX ~3200

• +80% of stocks at least 20% off 52-week highs

• +30% of stocks at least 40% off 52-week highs

It’s time to pivot Fed forecasts to a centerpiece of your trading framework. One of the biggest changes from the last 30 years is the Fed now expects and accepts recession conditions in their forecast. This has important considerations for present and future risk-taking.

Unlike past periods when growth data shows signs of weakening, there will be no life preservers thrown by the Fed. Wall Street is on its own. It has already been a “fast” (albeit late) rate hike cycle. The odds of recession are higher.

Earnings risk that occurs around U.S. recession periods. Many have suggested that current economic data makes clear a U.S. recession has not yet solidified. But risk doesn’t usually dip until after a recession begins.

Bottom line, the bulk of market correction to date has been in response to rapid shift in cost of capital and correcting peak valuations. Recession risk very much remains and history suggests the low doesn’t come until after the recession begins.

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