My opinion has changed somewhat since 2017. I am a pessimist much like yourself when it comes to markets and investing. The thing I have realised is that it is a lot like a board game now, let's say Monopoly. There are so many levers the US Government/FED can pull from thin air that it really is just a game. In the end if the financial system crashes, I could see an agreement where all economies (IMF) just print money and wipe all debt off the board, basically a reset or a redo with new rules in place. If this happens, there is a possibility of a reversion back to the gold standard or something thereof. The shift started in 2016, 2020 just sped things up.

Following up on the contrarian view I described above, I think that scenario would go something like this:
1. In early 2023, the shelter component of CPI rapidly declines to zero-ish (as 2022’s declines in house prices and rents feeds through to CPI), goods CPI remains benign, and the remaining services components of CPI ease (not completely clear how this happens, unless employment and wage growth weaken meaningfully, but whatever), thus total CPI eases to around the Fed’s target, on a monthly annualized basis anyway.
2. The Fed thus stops its tightening before significant further damage is done to the economy (another 100 bp or so).
3. There is thus no recession, just a mid-cycle slowdown akin to 2015-16. 2023 becomes one of the yield curve’s false alarms (there have been some for the 2Y/10Y, and even for the FF/10Y there may be a first time for everything - the events of the past couple years have been unprecedented in many other ways).
4. SP500 EPS for 2023 settles around $220-ish (i.e. flattish to 2022) and SP500 EPS for 2024 looks like $240-ish (i.e. growth resumes at 8-10%).
5. SP500 NTM P/E rises to 18X-ish (i.e. about where it got to in 2017, coming out of the 2015-16 slowdown.
6. SP500 price heads to 18X $240 = $4300-ish (i.e. about +9% upside from here).

This does not require EPS growth in 2023 or Fed to start lowering rates.

How plausible is this scenario? Something I’m thinking about a lot. I’ll be kind of pissed if it happens, as my positioning will be wrong, but I suppose that is a Grinchy reaction to possibly sparing the country a recession.

Edit: Since this scenario uses NTM (next twelve months) P/E, the hypothetical 18X would be applied at the end of 2023, on hypothetical 2024 EPS.

^^^ I like your reasoning.

Interesting.
But I don’t think #1 (“thus total CPI eases to around the Fed’s target”) is very likely by early 2023.

I always enjoy reading John's analysis. Me .... I'll just be winging it like I have ever since I graduated college back in '83 .... and back then....

Times were tough I tells ya ;)!

Not kidding...

^^^
Those slide rules were hard to read...but they worked.:)

https://media.gettyimages.com/id/171...HxzfLff3JFhjk=

Before my time ;). Though we couldn't use calculators in college, I did have access to some awesome computers at the Research Triangle back then .... and no jobs anywhere for most :(.

Perspective....

My first year of college....they built a new computer building.
The computer took up the whole second floor. Our terminals, on the first floor, had slide cards to communicate with the computer. 1972

In '78 I used punch cards too... then things changed "a wee bit" fairly quickly and never stopped :)

I think that is vital to the rosy scenario.

The Fed’s top priorityl is to kill the inflation dragon. No Fed since the 1970s has let inflation get out of control, this Fed doesn’t want to go down in infamy. The FOMC governors would prefer not to drive the economy into recession, but recessions are normal and not the end of the world, so they absolutely will take a recession if that is the cost of avoiding a repeat decade of stagflation. Powell is a big fan of Vockler and has made it very clear that higher unemployment, falling housing prices, a bear market in stocks, are all things he is willing to cause, if he has to.

So if annualized monthly inflation is still well above their target (meaning, month over month trend above 0.3% or so (which annualizes to 4%) I believe the Fed will not let up on the rate hikes and other tightening.

Unless, of course, something big and very serious “breaks” in the US financial system, since financial system stability is an even higher priority than controlling inflation. But I think the Fed is pretty confident in its ability to fix breakages - in 2008 and 2020, it proved itself very capable at crisis response.

John I wasn't really paying close attention back in '83, but inflation was still not dead yet, job market was horrible, and I seem to recall a "double dip" back then too....

....and life was good :)

What I don’t get, and perhaps someone can explain it to me, is this:

1) How can the govt, over a couple of years, print and give away literally Trillions and Trillion of dollars, and expect that the previously existing dollars would retain their value? How can that not be viewed as hugely inflationary (or, said another way, devaluing of existing dollars?) Because in pretty much every discussion I read or hear, that is rarely mentioned. How can it be thought that raising interest rates a bit (from essentially zero) for a few months can so easily “erase” that Trillions of printing? (This is what made the Fed claim that inflation was “transitory” so mind boggling to me. Did they really believe that?)

2) 2008 was bad in many ways, but as far as contributing to inflation the govt response was a pittance. Wasn’t it less than $1 trillion, most of which was loans that were paid back?

3) I don’t view the Fed as capably handling 2020. What did they do that was so capable or smart? It seems like all they did was be a participant in an undisciplined free for all orgy of unnecessary and overdone printing and spending.

I’m mostly interested in understanding #1.

I was graduating from law school in ‘83 with a huge stack of rejection letters from every job I had applied for. Jobs were not easy to find at all, even graduating from a top 10 law school (UCLA). It didn’t help that my summer internship had been with NORML. The only reason I got a job was my college roommate’s dad was a partner in a San Francisco firm, and he got the firm to give me a chance.

I was personally unaffected by the 1990 recession (and didn’t notice any bear market), but practically every junior associate in my firm who was doing real estate law lost their job or had to switch to some other kind of law. By the middle of the decade, a fifth year real estate associate was worth his weight in gold because there were so few.

In the 2000 bear market and recession, analysts all around me were getting laid off, in the gentle Wall Street manner wherein a security guard walks unannounced into your office, takes your keycard, and escorts you out of the building immediately, you come back on the weekend under guard to retrieve your personal stuff. Of 9 guys in my group, only 2 of us survived. Most of the others never got back into the industry - careers over for good.

The 2008 bear market and recession were gruesome. Five of us had started a fund, we lost 50% of the seed money in 2007 and 2008 (we weren’t idiots - it was a US small cap growth product with maximum 5% cash allowed, so there was nowhere to hide), lots of guys I knew got blown out and most of them never got back into the industry. That bear market went on and on, the financial system almost did blow up, consultants would come visit us and tease “you guys are still here?”. We hung on, nailed the bottom in March 2009, flipped the whole portfolio to the most aggressive names we could find (F at $1, etc) and were up +100% that year.

2020’s bear market and recession could have been the end of my career, not to mention the start of a global Depression. I went out on my own on Feb 4, 2020 - and the following week I was reading about air quality and crematories in Wuhan, buying up masks and respirators, and watching the market do what it did. But things worked out just fine.

I’m looking at the coming recession or not-quite recession, with my money still being on the former, with interest. None of us can say we’ve seen exactly this movie before, but after you’ve been around the sun enough, the movies start being sequels.

If you want to get into the weeds, it’s not just the supply of money (M), it’s the velocity of money (V). In a recession, people and businesses get scared, stop spending, dollars sit hoarded in bank accounts instead of moving through the system buying things. So you can increase M in a recession without creating inflation, because V is collapsing . You’re actually trying to keep M * V stable, to avoid deflation. After the threat passes, and V odd picking up again, you reduce M.

As a practical matter, though, what really happened is that in a few weeks, 20% of Americans lost their jobs or were about to, more than 20% of American businesses were starting at collapse, the US Treasury market was about to collapse, the same was happening around the world, and inflation was the least of anyone’s worries.

The US government threw $4TR at the real economy to keep people eating, housed, in business, not doing a Grapes of Wrath Depression remake. Remember that a large percent of Americans don’t have even two months of expenses in savings, and that a large percent of American businesses have large amounts of debt that has to be rolled over every year or more often.

The Federal Reserve threw $4TR at the financial system to keep it from blowing up. Remember that funds, companies don’t keep that much cash around, when they need cash they sell Treasuries or similar safe securities, and when everyone in the world is trying to sell and no-one is trying to buy, even US Treasuries go no-bid, prices plunge in big gap falls, and falls in prices make more funds and companies desperate if not insolvent, triggers massive margin calls, and the whole thing goes into a death spiral.

Almost every rich country - US, Europe, Canada, etc - that had the means to do the same did so. In the poorest countries, people went hungry. China and much of Asia resorted to intense lockdowns (what we called a lockdown in the US was amateur hour in comparison). The US and other Western countries are rich in money but not in social control, so we went the money route.

It worked. There wasn’t a global Great Depression, the financial system survived, most companies and businesses survived, etc. Maybe the dose given was too high, who knows, but the patient lives.

So now we have to deal with the after effects (over dose?), one of which is inflation. M went way up, V recovered, now M has to be pulled down.

The US govt is not really able to take back money it has given out, and even though the federal tap has been mostly shut off, a bunch of that money went to the states who are still handing it out. Things like China locking down and its effect on the supply chain, Russia invading Ukraine, have complicated things. Politics gets involved - it was involved in pouring the money in (remember Trump wanting his signature on the initial stimmy checks, to help with his re-election? and then Biden wanted his share of credit too?) as well. But the pandemic-driven excess in household bank amounts is being drawn down, it will probably be gone by mid-2023.

The Federal Reserve has a lot more ability to take back money. Driving the Fed funds rate from zero to 4% in less than a year pulls a lot of money out - house prices falling, bond and stock prices falling (something like $10 TR in stock market value lost in 2022, and a much larger amount in bond market value), companies less able to borrow, stupid crap like crypto and SPACs and NFTs imploding, now companies starting to layoff and freeze projects - and about $80BN/mo (about $1TR/yr rate) is also being pulled out via balance sheet run-off.

At this point, I’m not sure the money injections in 2020/21 are the most stubborn driver of inflation. They certainly drove house prices and rents up, but that is reversing quickly. The stubborn part now is labor shortages and rising wages. Some of that is people retiring early because their stocks went up or to trade crypto, but there’s other things going on.

I’m rambling, sorry, and phone battery about to die. Pick this up tmrw.

Edited: typos

If those dollars "go under the mattress" then they are not inflationary.

In 2008-9 I was counter the OMG QE-infinity!! freak-out because I saw that banks had already created that money (on their books). The QE created money covered that which had just evaporated(housing valuations) . So really, it replaced $'s to keep banks from failing.

And here we are now. On the heels of a global shut-down. Helicopter money to some extent and now a pull-back. - How many thousand IRS agents to claw money back? I digress... The US is not alone in Helicopter money. Other countries have been "printing" money as well. The US is not close to leading on that front (so I hear).

The big question is, where do those Trillions go?

We are sending tens of Billions to Ukraine. Does it circulate there? Does it get exploded in Russia? Does it come back to the US as corrupto-currency? Where does the money go? How much of it circulates? Because if it is not in circulation it will not drive inflation.

It seems to me that most of it (or at least a very large amount) was/is being spent.
I’m not talking about $2k checks that were mailed out.
Example: I know several people who have small business (5-10 employees) who got huge (now forgiven) PPP checks. In the $400-800k range. And the kicker is they were in businesses that didn’t need it, they had no decrease and likely an increase in revenue during Covid.
Someone gave me a link to a Govt site where you can look up the companies and amounts given, and I could see their names and amounts.
Which was shocking enough, but what was more shocking was the size of the list. As I recall it was thousands of pages long, with countless PPP loans of $10 million or more to companies you’ve never heard of.
Anyways, I saw how the money was spent by the people I know who received it. Lots of home improvements, construction, Pelotons, cars, jewelry and watches, etc.

That is interesting.

I do wonder how much the curve inversion is a head-fake. An effort to convince people that inflation will be just a blip - transitory, doncha know. Because when people think everything will cost more in the future, it does. (out from under the mattress it comes)

I expect tabs is right, buy the 3 month CDs to not go backwards as fast.

Thank you John and everyone.... interesting thread and perspectives by all! Personal situations vary, but what's the downside to buying long term CDs or Corp. bonds and locking into pretty decent returns over several years... assuming you're not broke, debt free, and have a pretty nice cushion against some long term inflation? The Fed might tighten a bit more, but I don't see it staying that way for years either .... moving back to 3.5-ish territory. I hope we NEVER return to the .25 Fed rates we had for almost two decades either.

Cheap credit - the opiate of the masses :(

Cold turkey is a beotch and here we are...

....and life is still good ;)

Very well said, I 100% agree with all of this.