Unfortunately, this will happen just as more people realize the US stock market is priced for a correction. The earnings expectations of many companies are far too optimistic, and they are running out of financial engineering tools to hide it. We have gone much too long without an extended correction. I believe we could see a 15–20% downturn if key companies miss their forecasts.
While multiple crises blanketing the entire Eurasian continent suggest that dollars will be flowing into the United States, the sovereign wealth fund need for liquidation will require the reverse. I defy anyone relying on anything other than an educated guess to tell me which will be the greater force. (Do Japanese pension funds continue to liquidate JGBs and buy US and European stocks? In what size? Do they wait for the markets to settle out? Inquiring minds want to know.)
Here is the real question: Can the US have a recession without an inverted yield curve? This is an ongoing debate I am having with several prominent economists. I would say yes. Although we have not seen a recession without an inverted yield curve since World War II, I think we are now in different times, with different underlying conditions, as noted above. Zervos and Rosenberg would argue that the Fed will continue to raise rates until we get the potential for an inverted yield curve, albeit at a lower rate than we have ever seen. I am doubtful that the Fed will raise rates more than two or three times this year. We are going to enter the next recessionary period with interest rates the lowest they have ever been. I defy you to perform an historical analysis that sheds light on future conditions under those circumstances. Which is why I’m concerned about the Fed giving us negative interest rates.
I’m actually far more concerned about a real bear market in stocks creating the conditions for a recession. Any of the three potential shocks I listed above could create a bear market and a US recession. Attention must be paid.
Jim Grant, who spoke at the same private conference in Hong Kong that I did, said he was worried that the US is already slipping into recession. I am certainly not ready to agree with that analysis, but I am not confident enough to disagree with my friend Doug Kass, who expects that the US will enter recession before the end of the year. My base case at the moment is that we will not, but we will continually teeter on the brink. For all intents and purposes, the result may feel like a recession. Which suggests to me that the data the Fed looks at will keep them from raising rates the four times they currently predict. I still think we will once again see 0% interest rates before we see 2% rates or maybe even 1% rates – depending (I say with a dollop of sarcasm) on the data.
Dangerous World
Looking beyond China and Europe, Latin America is a wild card. The strain of lower resource demand from China is beginning to show. Argentina has a new president, and Brazil may get rid of its current administration. I think we will see some dramatic swings in Latin American stock, bond, and currency valuations this year. Venezuela is on the edge of collapse.
Pulling all the evidence together into a strategy, my own plan is to avoid directional market exposure as much as possible. We should see plenty of volatility, and staying on the right side of it will be very difficult. I think certain targeted technologies will do well – mainly those that enhance productivity. Human workers will keep losing ground to artificial intelligence algorithms – a phenomenon that will continue to spread both vertically and horizontally in 2016.
I intend to direct more of my own assets into the private credit opportunities I mentioned two weeks ago. Thank you, by the way, to the many readers who wrote to me about the opportunities you’ve seen. A lot is happening below the radar, with very promising results so far. I’ll share more with you as the year unfolds and legal restrictions permit.
Bottom line for 2016: Don’t tie your fortune to a rising market – and I mean any kind of market anywhere on the globe. This is a time to think strategically, stay hedged and diversified, and avoid big directional bets. I think active and hedged management will be the place to be in the coming period. To quote the motto of House Stark in Game of Thrones, winter is coming.