As June winds down, the market (as measured by the S&P 500) is 25 percent off the highs. The NASDAQ is under water about 35%. The more aggressive stuff is about half or less of what it was 9 months ago. Crypto and the crazy stuff is off about 80 percent. For all intents and purposes, we are all feeling a little lighter in the wallet and poised for the next shoe to drop. The markets are signaling oncoming recession and the pundits are lauding the winter of pending discontent. As we ponder the future, I wanted to discuss a few of the possibilities and opine as to what they could mean. Believe it or not, there are numerous directions that could be game changers to the positive….
The hypothetical bad (because what else would we start with)….remember, this is descriptive of what COULD happen, not what WILL happen.
Scenario 1: The Fed is indeed late to the party and high inflation continues despite a series of rate increases through the summer and the macro environment stubbornly refuses to get better. While this would seem the obvious path of action, it’s not certain and a lot can happen to improve this outcome. Being worst case scenario, equity markets go down another 20 percent and bonds decline another 6 percent. Puts us on par with the 08/09 debacle which was painful. The economic end result is a period of stagflation that drags on well into 2023. Like in 2008, investing feels like death by roller coaster as we search for a level that holds. While we don’t subscribe to this, we need to acknowledge the theme.
Now that I have depressed the hell out of you, let's look at factors that could “go right”….
Scenario 2: The easiest is the longest shot but still possible. Putin ends up dead or has a severe “change of heart” and the incursion into Ukraine ends. Don’t laugh…. As we pointed out before, the Soviet parallel between Ukraine now and the past failure in Afghanistan is real and it’s a quagmire they don’t want. Massive wealth destruction and pain on the Soviet people is tolerated (for now) until it’s not. What was supposed to be a quick victory has become an embarrassment. Should it end, the result for investors would be a massive and immediate rally that could potentially hit “limit up” extremes. Essentially, investors who are out of the market could literally not get back in except incrementally when price and volume allow.
Scenario 3: What else could go right….supply chain disruptions begin to unlock in earnest. Already starting to see some of this but has a long way to go. The labor force is showing signs of improving (aided by the aforementioned wealth loss and fiscal policy changes). Technology enhancements are also showing some impact. Logistics will improve if not for any reason other than the profit motive. Is a question of “how fast” do they untangle?
Scenario 4: Another issue and cost driver are oil prices. Clearly not a news flash and the pain is real. Prices obviously must come down. But, and having learned the hard way over the year, my friends in west Texas have a saying…. “the cure for high oil prices is high oil prices”. As well head prices exceed $70 a bbl, the economic payoff for exploration and development is huge. Yes, I understand refining and distribution is also inefficient, but a lot of fresh investment money is being funneled to solutions. Bending the pricing curve downward will go a long way toward a positive outcome.
Scenario 5: One other clearly defined issue is the current labor shortage. Endemic across pretty much all industries, it has frustrated everyone. The “great resignation” from Covid to the extension of jobless benefits, to the new era of day and crypto trading caused an untenable situation. As the economics deteriorate, the upside is many will become re-engaged in the workforce. Add immigration and retirees reentering as part-timers, there is potential improvement which could greatly benefit the macroeconomic picture. As the pandemic memories fade, some number of folks are going back to work.
Scenario 6: Last, and certainly the most possible is that inflation slows for no other reason than supply and demand and the consumer just plain stopping. The price elasticity for most items was nonexistent as we emerged from the pandemic and pent-up desire meant prices had no consequence on demand. This is starting to slow significantly as evidenced by inventory buildup. Economically, there is a thing called the “substitution effect”. As consumers say no to high-priced goods, they substitute other lower-priced options. Big ticket items are already starting to slow. As interest rates rise, the cost of capital increases, and business slowdown starts to happen, this should take hold in earnest. It becomes a snowball effect and slowdown in one industry begins to spread to others. Generally, that’s how recession spreads. Many stock sectors are firmly predicting this with their stock price movements.
In summary, while the news and media outlets are hacking away on the negative and the worst-case scenarios, it is important to remember that life is not static and cross-currents of new inputs are constant. My dad had a saying…. “it’s never as bad as people say (or as good). Don’t get caught up in it, keep your perspective and stay balanced in how you look at things”. Today, this couldn’t be truer. As always, if you need anything, do not hesitate to call us on our cell phones at any time.