[jyl]

My two cents, again.

Probability of a synchronized global downturn in 1H23 is rising.

- US: Fed is focused on inflation, and will do what it thinks is needed to bring inflation back down to 2%, at the cost of a recession if that’s what it takes. Pundits are saying “Powell is going to be surprised when jobs go negative in 1Q”. Fed SEP (basically survey of FOMC members’ economic expectations) has unemployment 4.4-4.7% by end 2023, from 3.7% now, each 1% is 1.6MM jobs if no change in labor force, and Fed isn’t seeing growth of labor force, so that means Fed expects up to 1.6MM net job loss over 2023. So, no, Powell won’t be surprised. Pundits are saying “employment is a lagging indicator, Fed is driving looking in the rear view mirror, when it sees the downturn and job losses it will pivot and start lowering rates”. The Fed has more economic analytical horsepower than anyone, I think it is driving looking through the windshield, it sees the downturn and job losses ahead, and intends to keep driving to 2% inflation. So, unless inflation rapidly and convincingly recedes, the odds of a recession starting in 1H23 are rising. Oh, Powell knows goods inflation is declining and housing inflation will decline in 2023, but services are 55% of the inflation index and Fed believes that won’t be brought under control until it has forced the labor market “into balance”, and means job losses.

TL.DR - The Fed is not trying to “turn things around” if by that you mean avoid a downturn. The Fed is trying to kill inflation fast and avoid a repeat of the 1970s. Jobs, stock prices, house prices - all will be sacrificed if need be.

- Europe: ECB raised 50 bp, said it will not let high inflation expectations get entrenched, and will continue raising. Europe is being pummeled by energy costs and the Russian war. Their recession has probably already started.

- UK: Similar to Europe, with Brexit another self-inflicted wound. Similar to Europe, and BOE is explicitly forecasting a recession and raising rates into that.

- China: Their economy was bad already, Xi has gutted the housing sector and hobbled the tech sector, now they’ve hastily dropped almost all Covid measures and are starting what’s going to be a huge Covid wave, with mediocre vaccines, low vax rates, many vaccinations over a year old, and a very poor medical system. Xi has driven local governments to the financial brink with years of staggeringly expensive hard Covid lockdowns (what does it cost to PCR test the entire propulation of a city every three days?) and his economic reforms. Now he’s trying to revive the economy by reopening but economies don’t revive during a huge Covid wave with people hiding at home.

I think all this comes together in 1H23.

Bond market gets it. Bond guys are smarter than stock guys, when it comes to economics.

Stock market doesn’t. Equity investors see falling 10Y yields and think “yaay, raise valuations”. But it matters *why* 10Y yields are falling. Yields falling and inverting because the economy is slowing is not bullish.

Before CPI report, I took portfolios more defensive. That felt bad on Tuesday, by end of Wed SP500 had given up its CPI pop, and today I wish I’d gone more defensive yet.

For the sake of all the people who are going to get hurt, I should hope my outlook is wrong. But their sakes are their problem, and so I hope I’m right. I’m set up to survive the slide to low 3 handle with tolerable losses and emerge with mountains of cash to scoop up cheap stocks, and I want those bargains.