...will leave you with Mike's take on what is ahead.
...Look Ahead on what portends ahead, not the price movement on a day to day basis.
We're in the Eye of a Financial HurricaneBy Mike DiBiase
In the markets, an eerie calm often precedes bad times...Think about the end of 2021. The stock and bond markets were perched at all-time highs. No one was thinking about a new bear market back then.
Well, almost no one...
I didn't expect the calm to last. On December 23, 2021, I published an essay titled "2022 Will Be the Year the Markets Crash."
As we now know, 2022 was the worst year since 2008 for both the stock and bond markets.
Why did I think the markets would crash? One word: inflation.
I've been warning about the dangers of inflation since April 2021. Back then, virtually no one was worried about it.
Today, even in the wake of the recent bank failures, I'm still seeing optimistic articles and rhetoric...
Folks are saying that inflation is nearly under control... that the Federal Reserve will stop raising interest rates and will soon begin lowering them again... that the next bull market is about to begin.
Today, I want to warn you this calm will be short-lived. I believe we're in for a wild ride as this year plays out.
Remember, there can be an eerie calm
in the middle of a storm, too...
Think about a hurricane. After the devastating outer bands of the storm arrive, the calmer "eye" moves over. The center of the hurricane can be quite peaceful. Winds are less than 15 mph, and you can see blue sky or stars above.
Many people are fooled into thinking the storm is over when the eye reaches them. But the last thing you want to do is venture out into the eye.
Behind the eye are more devastating hurricane-force winds that are sometimes worse than the first part of the storm.
Today's calm in the markets reminds me of the eye of a hurricane... And I'm here to tell you the financial storm is far from over.I realize many people don't share this view. They think the Fed will somehow navigate a proverbial "soft landing"... meaning a kind of mild recession, or no recession at all.
For example, Treasury Secretary Janet Yellen says the U.S. will avoid a recession in 2023. So does President Joe Biden. I wouldn't put too much stock in the economic predictions of politicians.
Yellen and Biden didn't see the calamity of 2022 coming. And neither even acknowledges we were in a recession last year, despite the fact the U.S. gross domestic product ("GDP") contracted in the first and second quarters... the textbook definition of a recession.
But that's all behind us now.
Since then, GDP grew 2.9% in the third quarter and increased 3.9% in the fourth quarter. For many investors, that's an "all clear" signal that the worst is behind us.
Investors are also getting overly optimistic because inflation appears to be headed down. The Consumer Price Index ("CPI") was 6% in February. That's down from the high of 9.1% in June.
Based on Treasury futures prices, investors are betting the Fed will be able to start
cutting interest rates this year. This is highly optimistic, considering Fed Chairman Jerome Powell hasn't given any indication that he's even
considering cutting rates in 2023.
All of this optimism is based only on hope...Investors
hope that inflation is under control. They
hope the Fed will stop raising rates soon. And they
hope the central bank will start cutting rates and easing again.
Investors want their punch bowl refilled so they can go back to partying without worry.
I wish all of this were true. I'd love to tell you that we're at the starting line of a new multidecade bull market... and that we're about to enter a new period of low interest rates and easy credit.
But that's not my job. I am here to tell you the truth as I see it.
The truth is inflation isn't
anywhere near being under control yet. It won't even approach the Fed's 2% target this year. That means both interest rates and inflation are going to stay elevated for longer than most folks think.
Earlier, I mentioned I was warning about high inflation back in April 2021. You might wonder how I understood what was going to happen with inflation before nearly everyone. It's simple and logical...
I turned to the source who understood inflation better than anyone else. I'm talking about the late Nobel Prize-winning economist Milton Friedman. Using his framework, it was easy to predict that prices were going to soar in 2022.
Friedman understood that inflation is always caused by the same thing – a more rapid increase in the supply of money than in the output of goods and services. Never before in history had our nation's money supply increased so much so fast than following the pandemic in 2020.
Here's what's important today...Friedman not only understood what causes inflation, but also
what it takes to cure it. His analogy to alcoholism is worth repeating...
When you start drinking or when you start printing too much money, the good effects come first, the bad effects only come later. That is why, in both cases, there is a strong temptation to overdo it – to drink too much or to print too much money.
When it comes to the cure, it is the other way about. When you stop drinking, or when you stop printing money, the bad effects come first and the good effects only come later. That is why it is so hard to persist with the cure.
Friedman understood that it's difficult to get rid of inflation once it takes hold. He explained that there's no easy, painless way to cure it. The only way is to persist with a combination of higher interest rates, higher unemployment, higher taxes, and a contraction in credit and the money supply.
These are the "bad effects" he was talking about.
In other words, to cure inflation, we have to go through economic pain. There's no avoiding it. A 20% drop in the stock market doesn't qualify as economic pain under Friedman's framework.
Using Friedman's analogy, 2020 and 2021 were the party years. We were all happy and drunk on the Fed's money printing.
In 2022, we began feeling dizzy and sick. We realized we "drank" too much and that the party was over.
We haven't gone through the real pain yet. We're now about to pay the price for our excess. 2023 will be the year of the hangover.
Last year's recession wasn't deep or long enough to bring demand and prices down. Until that happens, I predict that inflation is going to stay elevated above 5%.
You can't bring down inflation with record employment.
The Fed said the unemployment rate needs to rise to at least 4.5% from today's near-record low of 3.6%. That means around 1.5 million folks will lose their jobs as the economy contracts.
And that means big trouble for our economy.
A recession in the U.S. is all but inevitable this year...The best recession predictor flashed a major warning signal late last year. The spread between the three-month and 10-year Treasury yields inverted.
Over the past 60-plus years, this spread has inverted eight times. And every single time a recession followed... with no false signals. It's the recession predictor the Fed uses. This spread today is the most inverted it has been since 2001.
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Other recession indicators are foretelling the same. The more widely quoted indicator – the "2-10 spread" – was recently more inverted than at any other time since 1981. (It measures the difference between two-year and 10-year Treasurys.)
Folks who are predicting a mild recession – or that we'll somehow avoid a recession entirely – remind me of the folks who said inflation wouldn't be a problem.
They were wrong back then, and they'll be wrong again.
If you don't believe me, all you have to do is look at the deteriorating financial condition of the American consumer.
It's going to be a crappy year for many Americans. You're not hearing enough of this story in the mainstream media.
The reality is that the U.S. consumer is in deep, deep financial trouble. As conditions worsen in the coming months, you should expect to read more and more headlines about it.
Many investors don't realize how bad things are for the average American. They remember how the Fed lined their pockets with stimulus money after the pandemic. Back then, consumer balance sheets were in fantastic shape.
The U.S. personal savings rate – the amount families have in savings compared with their disposable incomes – soared to a record 34% in April 2020. That was more than triple the 9% average savings rate over the past 60 years.
But things have changed dramatically for the average American in a very short period of time...Those savings have been depleted. Nearly 60% of the country lacks the savings to cover a $1,000 emergency.
Folks are borrowing just to pay the bills. Credit-card debt just eclipsed a new record. In the most recent quarter, credit-card debt soared 15% from last year to $986 billion.
This debt is a huge problem for consumers because credit-card interest rates just hit an all-time high in December... soaring to more than 19%, according to financial website Bankrate.
In other words, credit-card debt is now far more burdensome than it has ever been.
Folks are getting poorer... and deeper in debt. Household debt – including mortgages, credit cards, car loans, and student loans – has soared to nearly $17 trillion. That's 33% higher than its peak during the last financial crisis.
Debt amounts to an average of $126,000 for every household. That's a 100% increase over the past 20 years.
Meanwhile, wages haven't kept pace with rising debt or prices. Household income, adjusted for inflation, has only increased 9% over that span.
Despite near-record-low unemployment today, "real" wages – wage increases minus inflation – have
fallen 7% since the pandemic.mce-anchor
Nearly two-thirds (64%) of all Americans are now living paycheck to paycheck.
These are startling numbers. They should worry any investor, considering that consumer spending makes up around 70% of the U.S. economy.
Interest costs are eating up more and more of consumers' budgets...And conditions are getting worse. Interest rates are still rising.
The Fed just recently raised the benchmark federal funds rate by another 50 basis points ("bps") to a range of 4.5% to 4.75%. That's the highest rate since October 2007.mce-anchor The central bank is projecting it will continue raising the federal funds rate to around 5%.mce-anchor
That has driven up interest rates across the economy. Mortgage rates have more than doubled since the middle of 2021, to around 6.6% on a fixed 30-year loan. That's the highest they've been in 20 years.
The average home price in the U.S. is around $350,000. The monthly mortgage payment on a loan to buy a $350,000 house is nearly 50% higher today than before the pandemic.
Housing, cars, and food make up around two-thirds of consumer budgets. Those costs rose 9% in 2021. They've risen even faster this year. In the CPI data for February, shelter costs rose 8%... transportation jumped 15%... and food increased 10%.
That doesn't sound to me like inflation is subsiding.
Adding this up, the American consumer is faced with...
- Near-record-low savings
- Record-high debt
- Record-high (and still rising) credit-card interest rates
- 40-year-high inflation
- And falling real wages
The math simply doesn't work.
This is going to end in financial disaster.
Here's the unavoidable truth... The economic reality for most Americans is getting worse by the month.
Knowing all of this, it's not difficult to see where things are headed...Discretionary spending and consumption will fall sharply this year. The economy will contract. Businesses' sales and profits will fall as a result... leading to more layoffs and pressure on wages.
Credit-card and auto-loan delinquencies will also rise. Car repossessions will soar. Americans will default on these loans at levels not seen since 2008.
And credit will tighten. This is not some worst-case scenario theory. It's already happening.
Corporate America has a debt problem, too. Corporate debt totals $12.8 trillion. That's nearly double the $6.6 trillion it reached at the peak of the 2008 financial crisis.
This debt is also getting more expensive as interest rates rise. And it will get even
more expensive for another reason... the hit to profits.
Corporate profits will fall sharply this year for the first time since 2008 (not counting 2020, the year of the pandemic).
That will happen because of persistent inflation and a contracting economy.
As profits fall, interest costs get even more burdensome.
mce-anchor
What the Fed does when the pain arrives will be the pivotal moment of 2023...If the Fed takes the advice of the late Milton Friedman and doesn't ease, the recession will deepen throughout the year. Bankruptcies will soar, and many "zombie" businesses – that can't afford to pay the interest on their own debt – will go under.
If this happens, the credit bubble will burst in 2023.
Although painful, this is a necessary outcome. It will cure our economy of inflation and its excessive debt.
On the other hand, if the Fed can't persist with the inflation cure and instead begins easing, the economy will
temporarily recover. Credit will loosen, and we'll avoid a credit crisis... at least for a short while.
This is what I believe is the most likely scenario. Milton Friedman would agree. He has seen the central bank give in many times in the past. As he once explained...
In the United States, four times in the 20 years after 1957, we undertook the cure. But each time we lacked the will to continue.
But a so-called Fed "pivot" will only make things worse, as short-term solutions always do.
Later in 2023 and into 2024, inflation will soar once again, just like it did in the late 1970s when then-Fed Chairman Arthur Burns eased too fast. If that happens, I predict the credit bubble will pop in
2024.
The coming economic pain is the unavoidable consequence of printing more than $6 trillion of new money and keeping rates near zero for far too long coming out of the depths of the pandemic.
Now, the credit bubble is on the verge of bursting. It's only a matter of "when."
