Leading off last week's Hedgeye Investing Summit, two veteran, macro pros – “Papa Bear” Keith McCullough and “Mama Bear” Steph Pomboy – delivered a (very) sobering reality check.
Three important points:
- Yes, Keith and Steph are two savvy macro strategists who both happen to be bearish.
- Yes, their recent Hedgeye Investing Summit conversation is an absolute, must-watch.
- Yes, it will help you more effectively position your portfolio for what comes next.
Here’s a fantastic quote from Steph:
“When you take an economy that has twice as much debt as it did going into the Great Financial Crisis and you raise rates on it in unprecedented fashion, you’re going to cause major dislocations … The idea that we’re going to have some soft landing, or no landing, is just absolutely laughable.”
But wait … There’s more.
Below is a transcript of a critical segment of this conversation between Steph and Keith. The replay to watch the entire 46 minutes is also available.
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Keith McCullough: On this day in 2008, Ben Bernanke said something to the effect of, ‘If we have a recession, it will be a mild one.’ Track record intact at the Federal Reserve. In most of your recent writings, you’ve been alluding to 2008. All cycles are different, but take a step back to that and why you’re making the comparison.
Steph Pomboy: When I talk about how this downturn is going to be equal to or worse than 2008, I use that as a framework to give people a sense of how significant it could be. As you said, every cycle is different, but the amount of leverage built up into the system that is going to have to be unwound on the back of these rate hikes that the Fed has undertaken.
What’s particularly unique about the current cycle is the speed and magnitude with which the Fed has raised rates on an economy that is toting twice as much debt as it was going into the Global Financial Crisis.
You hear routinely these throwaway lines like ‘Yeah, but consumer and corporate balance sheets are strong.’ Well, when you dig beneath the averages, that’s not true at all. The household balances aren’t as bad as going into the housing bubble bust going back to 2006, but the corporate sector is really in rough shape. It’s obscured by the law of averages. It’s highly skewed between the haves and have-nots in the corporate sector. All of that will become plainly evident.
When you take an economy that has twice as much debt as it did going into the Great Financial Crisis and you raise rates on it in unprecedented fashion, you’re going to cause major dislocations.
The idea that we’re going to have some soft landing, or no landing, is just absolutely laughable.
The idea that it was just SVB or the regional banks or commercial real estate reminds me very much of Ben Bernanke’s ‘isolated and contained’ comment, which I think was in 2007 when the asset-backed commercial paper market started to come unglued.
Of course, that was just the beginning of lots of fun and games.
McCullough: Let’s keep this going. Let’s go down the bull path. We know what their talking points are. They’re widely disseminated. They generally have to do with the average of things. If you take a fractal approach, it’s the particular thing at the particular moment in time that matters and we’re in that window of clock time. I want to do that on both the consumer and corporate side. They’re both really important.
Apparently now everyone knows that corporate real estate is ‘contained’ but nobody called it a risk 3-6 months ago. Let’s start with that one because I get that a lot. I’ll be on an institutional client talk but they’ll say, ‘I hear you, but what’s 1.4 trillion in maturities between friends? Isn’t that just unique that particular part of the market, Keith?’
Pomboy: The idea that it’s just the commercial real estate market is a joke. The Fed had this free money bonanza for the better part of a decade following the financial crisis. Obviously, everybody took advantage and some people took more aggressive advantage. That’s starting to be made clear. What you’re seeing, as you always do, is the weakest links in the chains are breaking first. But that doesn’t mean the other links in the chain are going to stay intact. Inevitably all these problems bleed out.
As I alluded to, in 2007, you started to see the asset-backed commercial paper market start to come unglued and Bernanke said it was, ‘isolated and contained.’ But the problem with excess leverage wasn’t that it was just in that market, it was everywhere. That was because the Fed presided over interest rates that were held too low for too long and everyone took advantage. Why wouldn’t they? If you think it’s ‘isolated and contained,’ give it a minute because this is clearly going to devolve in a variety of ways.
The corporate credit market is my primary concern because we’re facing a maturity wall in the immediate future here in terms of paper that needs to roll. If you were a junk borrower, borrowing at 4% a year ago, now you’re borrowing at 8.5%. That’s a problem. And I don’t think anyone is focused on that.
There are a number of places to look at. In consumers, we’re already seeing delinquency rates rising in credit cards and auto loans. This whole ‘buy now, pay later’ thing has, not surprisingly, turned out to be a complete disaster. This is everything, everywhere, all at once in terms of the impact of higher interest rates on an overly levered economy across every sector.
McCullough: Let’s just do other sectors. I’m showing C&I lending cycles (pictured below). There are only three red bars in this chart. Doesn’t it just stop tomorrow because Jamie Dimon had a good quarter?
Pomboy: Silly me. It’s one of those things where you have to admire their optimism. This eternal optimism that says, ‘This time it will be a shorter and shallower hit from the tightening of credit conditions.’ I enjoy it because if everyone grasped the magnitude of what is about to happen right away and the markets did a complete flush, it would be quick and we’d be through it. It’s this refusal to acknowledge the reality staring them in the face that causes this long grind where you have a rally on the hope that things will not be this bad, only to be punched in the face with the next SVB or commercial real estate default. It makes for an entertaining spectacle.
Watch the entire 46-minute interview here.
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HEDGEYE INVESTING SUMMIT REPLAYS
KEY QUOTES FROM AYESHA TARIQ (CO-FOUNDER, TRADERADE)
- “Many analysts haven't seen this part of the cycle. It’s not that they don’t want to tell us, but they’re living in la la land a little bit. They don’t know how bad it might get or can’t remember."
- "The Fed can and will hike into a recession if they need to. They’ve done it before. Powell said he’s not afraid to overtighten, and if that’s the case, we’re in for some trouble."
- "The Dot.com bubble is very similar to what we’re seeing here. We’re throwing money at AI and the metaverse and whatever new concept comes up. AI is either intelligence or it’s artificial, but it can’t be both."
KEY QUOTES FROM BEN HUNT (CO-FOUNDER & CIO, EPSILON THEORY)
- "We have four banks that are too big to fail. The problem is the hollowing out of all the banks that aren’t too big to fail. It’s a world of two banking systems."
- "You can’t run a company in the real world on a 250K insured account. It’s also not the real world to think four major banks can provide what the real economy needs. It’s a real problem,"
- "Failure needs to be possible, and at the highest level, it seems like it's not possible."
- "In March 2009, I think the Fed saved the world. I really do. The problem is that emergency government action becomes permanent government policy."
KEY QUOTES FROM LIZ ANN SONDERS (CHIEF INVESTMENT STRATEGIST, CHARLES SCHWAB)
- "I'm surprised there are still so many adherents to 'no recession' or a 'soft landing.' You don't hear 'NO landing' much anymore. Every time I'd hear that, I'd say out loud, 'What are you talking about?'"
- "A Fed pause will make sense at some point, but a pivot will only come if there's much more stress in the banking system or we really see a hit to the economy and specifically the labor market."
- "We have the lowest percentage of stocks within the S&P beating the S&P on a rolling one-month and three-month basis. The last time the percentage was this low was 1999, which is never a year you want to mention when talking about the equity market."
- "You can apply screening for factors across the entire market: Tech (XLK), Healthcare (XLV), Utilities (XLU). It’s a factor-oriented market and it’ll stay that way for a while. It’s a better way to make decisions than monolithic sector calls."
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KEY QUOTES FROM LYN ALDEN (FOUNDER, LYN ALDEN INVESTMENT STRATEGY)
- "My approach is to take institutional research and put it into plain English. The funny thing is institutional people appreciate that too.”
- "Last month was a liquidity crisis, now it’s evolving into a profitability problem. The Fed has facilities to reduce liquidity problems, but then they have rising deposit costs overlaid on top of that."
- "I’m cautious on equities for the next several months. There are attractive areas longer term, but until we have more clarity on this liquidity situation, we see a storm on the horizon. It’s unclear how they’ll handle it."
KEY QUOTES FROM GIO VALIANTE (PERFORMANCE COACH & PSYCHOLOGIST)
- "You have to protect confidence and motivation at all costs. Why is that? The inverse of confidence is fear, and when you approach the markets from a place of fear, it distorts our ability to see things accurately."
- "Serious people take Hedgeye seriously. Why do they take you seriously? You tell the truth. The work ethic, the transparency. There's no hiding."
- "The psychology of the average will tell you there's no difference between who you are and what you do. Tell that to Kobe."
KEY QUOTES FROM DAVID SALEM (HEDGEYE DIRECTOR OF CAPITAL ALLOCATION)
- “Over the past 40 years, investing has moved away from the traditional 60/40 split. Our strategy at Hedgeye is 'go anywhere.' The strategy now adopted by Wall Street is aptly defined as 'go everywhere,' which means you have to own a slice of everything."
- “We try to fit newly arriving pieces of the puzzle into a pre-existing pattern, and that’s where experience can actually be a handicap. Of course, some of the things we’re seeing look very similar to 2008 or 2001. But again, we get back to Mandelbrot and the particular.”
KEY QUOTES FROM JIM BIANCO (PRESIDENT, BIANCO RESEARCH)
- "The minute the Fed started raising rates, the new pastime of the country became chasing money market yields."
- "The Fed raised rates too fast and that's part of the problem, but let's not forget that 12 years at 0 set this problem up, and that's equally as big an issue. Let's not excuse them from that."
- “If the Fed raises rates in May and creates more 5% money market funds, the bank walk becomes a bank power walk. It's even more enticing to move money because of those higher rates. This is the dilemma the Fed is in."
- "If the bank system gets squeezed, Wall Street will say 'Look at Morgan, look at Citi. They're OK.' True, but small and regional banks won't be. If they get squeezed, local businesses will feel it, and the economy will feel it."
KEY QUOTES FROM DAVID ROSENBERG (FOUNDER & PRESIDENT, ROSENBERG RESEARCH & ASSOCIATES)
- "Since 1950, we've had 14 Fed tightening cycles, always with good intentions, and they landed the economy in recession 11 times."
- "There are a lot more problems than just unrealized losses on Treasuries on bank balance sheets. And it's not residential mortgages this time. It's commercial real estate, which by the way is now a 3 trillion asset on bank balance sheets."
- "Banks now are going to be focused much more intensively on their balance sheets, and it means they're going to be curtailing credit to everybody outside of the most credit-worthy borrowers."
