The guest commentary below was written by Joseph Y. Calhoun, III of Alhambra Investments on 9/18/22. This piece does not necessarily reflect the opinions of Hedgeye.

Market Musing | What Changed? - Camoflauge  1

The S&P 500 fell 4.8% last week and is now down 19.4% year-to-date. Bonds were also down with yields up all across the yield curve. Gold was down 2.5% and the GSCI commodity index was down 2.3%.

Rate-sensitive REITs were down nearly 6%. The list of what went up last week would be quicker: the dollar, platinum, silver, and some of the agriculture commodities. That’s about it.

So, it was a lousy week but maybe we should zoom out a little. Stocks generally made their low in mid-June with the S&P 500 hitting an intraday low of 3636.87 on June 17th.

We closed last Friday at 3873.33 so we’re still well above the lows (although a couple more days like last Tuesday would get us down there pretty quickly). The 10-year yield peaked at 3.48% on June 14th just a few days before stocks hit their low. We closed Friday at 3.45% so, close, but still below the previous peak.

All the other asset classes we track are also above their lows (although some of the lows were July) with the exception of gold which continues to struggle with rising real rates.

If the June stock market lows really were the lows for this cycle, this latest pullback would be just a normal retracement; it wouldn’t be out of the ordinary when we looked back with the benefit of hindsight. In fact, we probably wouldn’t even notice it. But we don’t know if the June low was the low for this bear market.

So, what has changed since June? Well, it turns out not much. The economy is flatlining as it was back then. The first half of the year saw GDP contract slightly and GDI expand slightly and I interpret that as little to no growth.

It isn’t recession and it isn’t growth and it isn’t good but it isn’t a new crisis either. I see nothing in the data for this quarter that moves us off that trajectory, higher or lower. The trigger for the selloff last week was the latest CPI report which didn’t show as much cooling in prices as everyone hoped to see.

The immediate market reaction was to factor in more Fed tightening and that required a markdown in stock values.

The money market futures I follow and the market-based models I track all put the peak in rates somewhere between March and June of next year.

What that means to me is that, for now, the earliest we might enter recession would be March of 2023. Every recession since 1950 has seen short-term rates (3-month T-bill rate) peak before or within a couple of months after the onset of recession.

Of course, rates peaking and then falling does not have to be associated with recession but if we assume that’s where we’re headed, then the earliest we get there is spring.

Stocks would be generally expected to sell off before the onset of recession – markets anticipate – but the lead time between market peaks and the onset of recession can be as short as a couple of months or over a year. The average time from stock market peak to the onset of recession since 1957 is 6.4 months so we’re well past that already.

Since 1980 the longest lead from stock market peak to recession is just 7 months in the 2001 recession. We’re now 8 1/2 months past the stock market peak and still not in recession. We also have no way of knowing how deep or shallow any recession might be, so it is hard to judge whether stocks have fallen sufficiently to discount it.

One of the things I’ve struggled with in this cycle – and I think a lot of people have – is that this bear market is so much different than anything we’ve experienced in recent decades.

Indeed, considering COVID, it is really unprecedented. I tend to think though that comparing today to anything in the post-2000 era is probably not a good idea. We did have some higher inflation in the post dot com cycle but CPI YoY peaked in July 2008 at 5.5%. That’s high but nothing like today.

So, I’ve been looking back at the 60s, 70s, and 80s for clues about what to expect. Inflation rose steadily from 1965 to 1970 (1% to 6.4%) and spiked rapidly in the post-Bretton Woods era (dollar delinked from gold).

Today seems somewhat similar to that period (72-74) when inflation rose from 3% to 12% in a little over 2 years, although today’s strong dollar doesn’t fit the narrative.

There was another rapid rise in inflation between 1976 and 1980 (5% to 15%). What stands out about all these periods is that stocks were more correlated with inflation than interest rates, which tend to peak first.

Stocks fell when inflation was rising and tended to bottom right around the peak in the year-over-year change in inflation.

Which makes the June lows in stocks this year very interesting; that is, so far, the peak in the year-over-year inflation rate. What is different from that pre-1980 recession though, is that if that proves to be the peak it will have happened outside of recession.

The peaks in ’70, ’74, and ’80 all happened during recessions. As I said, today’s economic environment is nothing if not unique.

We will hear from the Federal Reserve this week and the expectation is that they will raise the Fed Funds rate by another 0.75%. There is a small chance of a 1% hike but I have my doubts.

They don’t like to surprise markets so if they were going to do that I think they would have leaked a story to the WSJ by now. I suppose they could still do that Monday or Tuesday but I’m not sure what they would gain from doing so.

The question for the market though is not what they do at this meeting but what they signal about future meetings. I don’t have any idea what Jerome Powell will say but the market seems braced for the worst.

It is often instructive to look at past markets and see how they reacted to various economic conditions. But no periods are ever exactly the same; this is not the 1960s or the 1970s.

Furthermore, getting the economic cycle part right – figuring out when the recession starts and ends – may not help you get the market reaction correct. Sometimes bear markets start well in advance of recession and sometimes they come just as the recession is starting – and oh, by the way, all bear markets are not associated with recession.

Sometimes bear markets end before the recession and sometimes months later. Why? Changes in human behavior, changes in information systems, changes in how the Fed manages monetary policy, and the list goes on.

I don’t know if we’ll have a recession next year but I do know that’s what is expected. Spend an hour watching CNBC or Bloomberg and you’ll hear “recession next year” over and over from all corners of Wall Street.

Maybe. But the market rarely does what everyone expects. So how will “Recession 2023” be wrong? Will it come before then or later or much later?

All I know for sure is what we have right now. Short-term interest rates are still rising and getting a recession while that is happening would be nearly unprecedented.


Joe Calhoun is the President of Alhambra Investments, an SEC-registered Investment Advisory firm doing business since 2006. Joe developed Alhambra's unique all-weather, multiple asset class portfolios. This piece does not necessarily reflect the opinions of Hedgeye.