A Rolling Recession or a Hard Landing? ft. David Rosenberg & Liz Ann Sonders

29:21And to me, that's far more important. You see, in the 1970s, the Fed didn't have the 1970s to compare the situation to, but now they do. Now they know the mistakes that they made in the past. So I think they're going to be very late. I think they'll be cutting rates aggressively, but the timing is uncertain and it might not be till the second half of next year before they do. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision daily briefing.

29:51Lizanne, do you think that we have to see more significant weakening in the labor market for that to happen? I'm very interested in wages as a larger share of GDP than profits. We, this week, are facing a big deadline for the United Auto Workers. We've seen unions pushing through wage increases. How are you thinking about the labor market? I don't know if it's set to look like the 1970s in terms of unionization as a share of the workforce, but we are starting to see the muscles getting flexed on the part of labor and greater demands coming from what is a less organized labor force. But you're seeing that change.

30:31Now, the convergence that has started in terms of profits as a share of GDP and labor as a share of GDP is not significant yet. You're still sort of in that upper range for profits and lower range for labor. But the convergence that has started is worth watching. And I think the pressure on profits for that and other reasons in this environment is one that suggests that gives way. And, you know, to sort of go on a sort of a side note off of what Dave said with regard to deglobalization, I agree with that. I don't use the term deglobalization. I don't think that that is really the force that we're seeing.

31:13I think it's a combination of, you know, on-shoring, supply chain, diversification, regionalization. We're certainly seeing more global factions formed. That's undeniable. That's already happening. And I think it just means an environment where companies in the past had the flexibility to be so cost-minded in terms of acquisition of labor, access to energy as we think of that broadly. And I just think that that environment is changing. And I think what the pandemic taught a lot of companies is they want to be not just just in time minded, but just in case. And availability and security of supplies through the chain is maybe at least as important than the cost structure.

32:09And I think that that has the possibility of continuing to compress this profits versus wages dynamic. And I just think it's a slightly more unstable world. I don't disagree. I think the Fed is going to be much more forceful in not allowing inflation to be let out of the bag again, not pulling an Arthur Burns and declaring victory two key times in the 70s only to see it reignite. And that's what brought Paul Volcker in to have to do what we now say, pull a Volcker. But I also think that because of forces around maybe less flexibility on the part of fiscal authorities, maybe even on the part of monetary authorities, and maybe flexibility isn't the right term, but I think less willingness to go to the zero bound in the case of the Fed into the negative interest rate bound in the case of global central banks.

33:07I think that experiment had, I think, more negative, possibly unintended consequences. So I just see an environment of less inflation stability. We just had that massive move down in inflation, in interest rates for 30 years or so. And the math is such that you're not going to repeat that in the next 30 years. And I just think across the spectrum of the economy, inflation, geopolitics, I just expect more volatility, more variability. And that just, again, feeds into a different backdrop than the Great Moderation era. Maggie, can I offer a retort? Please. You know, I'm just, I mean, I was hearing the same thing, for example, I said earlier after Trump got elected in 2016.

34:03and uh if you remember uh you know he was uh running against uh hillary uh who uh was a pro free trader and and trump if you remember trump wanted to renegotiate uh the free trade agreement the nafta uh he ended up building the wall restricted immigration uh raised tax lower taxes, a trillion dollars at the peak of the cycle. And if you remember that the unions in 2016 supported Trump, they didn't support the Democratic Party in that national election run. And everybody was talking about populism and reflation under Trump. And, well, you know, we never got that. And so I hear a lot about the boom in union wage settlements.

35:03But it's a lagging indicator. It's a lagging indicator. Believe me, I'm a capitalist. I'm not pro-union. I would just say that look at the reality of the situation. These people were stuck on multi-year contracts, earning 3-4 % as inflation surged. Their real wages were crushed. And everybody knows, and the only thing I'll ever agree with joe biden on was when he talked about the opportunity the corporate sector took during covid and after the worst parts of covid to boost their profit margins we went into this thing with profit margins at an all-time high and there's nothing the unionized sector could do about it so all they're doing is marking up for lost time and lost real wages this is not going to create the conditions the corporate sector if you read beige book after beige book after beige book and We just got the last one a couple of weeks ago showing the corporate sector is having increasing difficulty in passing on cost increases.

36:04As the economy is in complete different shape, there is no longer free money for all, and consumers are changing the way that they shop. There's no capacity for the corporate sector to pass these on. So they either have to cut costs in other areas, boost productivity, or take it on the margin. So if you're going to ask me, out of all the things that have been mentioned, and I guess I'm not really concerned about partial or reshoring in terms of the inflation. I think that'll be basis points per year. It'll be impotisional. And I'm not concerned about wages. One iota. One iota because they're a lagging indicator.

36:39In fact, there's so much academic research showing that it's inflation that feeds into wages, not the other way around. It only becomes the other way around, Maggie, when the Fed is accommodating the shock. But the Fed's not doing that. So I think we can just put the wage story aside. It is not going to be a pervasive source of inflation down the road. Can the U.S. economy, David, and the global economy handle higher rates? So even if they cut, if we are now looking at rates that stabilize somewhere, you know, three, four percent, not back down to that zero percent. Some people would say that's returned to what we had before.

37:23Can the U.S. economy and the global economy handle that? Well, we're still going to be faced with the lags of the monetary shock we've had over the course of the past year and a half. And there's no get it a jail free card from what's already happened. and interest rates hit the economy with lags in both directions. So if the Fed starts to cut rates next year, and look, just to get to neutral, they've got to go to 2.5 % of the funds rate. I mean, think about that. Just to get to, this is the tightest monetary policy stance since 1981. And everybody's got inflation on the brain. 1981, the only person calling for recession on Wall Street was my good friend Gary Schilling, who summarily got fired by Don Reagan for doing that.

38:08Don Reagan, who then wanted Ronald Reagan to fire Paul Volcker for daring to cause a recession. And he caused - I like how you're out in those names. Just reminding everybody. You can't make this stuff up. Of course, there is nothing. It's as Albert Einstein famously said, the power of compound interest is the eighth wonder of the world. And it impacts on both directions. So of course, if the Fed cuts rates and cuts rates sufficiently and re-steepens the yield curve. And we built up enough pent-up demand. Of course, 2025 probably sows the seeds for an economic recovery. We're talking about the business cycle.

38:44The business cycle, the market cycle, the industry cycle, they are all these sine waves, these centrifugal forces that intersect with each other. So of course, if the Fed eases enough, we're going to blaze the trail for a recovery. But are we putting, you know, which comes first, the chicken or the egg? The recession will come first, and then we'll talk about the recovery. once the Fed responds to the recession pressures. I want to bring a question in, and then I want to hear where you both think opportunity is. We have a question for you, Lizanne. Does the presidential election in autumn 2024 reduce the probability of a large decline in equity prices as the main interest of the government is to present a good world before the election date?

39:26I mean, I think they're saying they want to make sure everyone's feeling good about their - Yeah, I mean, that's that's the tie-in to the four-year presidential cycle and typically the third year being the best in a presidential cycle. But, you know, I look at seasonals like that, like anybody else does, but I certainly wouldn't bank everything on that on an every year, every cycle basis, because there are always outliers. It's also the case that you can have a strong year in the lead year, the third year. But if you've gotten a recession that is in the actual election year, the incumbent doesn't win.

40:04So there's so many forces at play that I think there's too many people that just sort of share a simplistic answer. They do it either based on historical cycles or sadly, in many cases, via expressing a political view and then saying this is going to happen or this isn't going to happen. I try to frame things based on everything going on at the time with a hefty dose of what's happened in history. So the short answer is, I don't know. One thing I will say to the topic we were discussing just before this as it relates to the election year, is that I agree that the Fed probably will have impetus at some point to start cutting rates.

40:52But the fact that embedded in expectations right now is still four rate cuts next year happening in the beginning part of the year, not the latter part of the year. I just don't see an environment where inflation hasn't gotten yet to the Fed's target. The labor market, although plenty of cracks have appeared, is not imploding. And you've got a 3.8 on the unemployment rate. The idea that from a Fed that has been pounding the table on, we want to, once we get to the terminal rate, our inclination is to stay there until we're pretty sure that they don't use this terminology. We've slayed the inflation dragon.

41:35I think rate cuts are a possibility, but not absent deterioration in the labor market. The idea that, oh, maybe there's in the mind they'll say, I know, you know, we're comfortable now with three to four, even if they don't change their target. Unemployment rate is not going up. That may be a perfectly legitimate scenario for the pause to persist. It doesn't really provide a green light for the Fed moving so quickly to rate cuts. So to people who say, you know, rate cuts are coming next year, that's going to be incredibly bullish. I often think, boy, be careful what you wish for, because the conditions that would cause the Fed in short order to pivot, not just to pause, but to pivot, those are probably recession-type conditions.

42:24Yeah, the bad news is bad news in that case. David, is there timing for rate cuts that you have in mind? Do you think it's sometime next year? Well, look, this Fed is a different Fed than we've seen before. And he compared himself to Paul Volcker and nobody else. And so I think the Fed's pain threshold is going to be higher than it was under, say, Greenspan or Bernanke. so the timing is hard to figure out right now let me put it this way is is do you share Lizanne's concern that the market is too aggressive in what they're expecting no no no I think that look the Fed look the Fed has been barking and barking and barking about harder for longer that's what they want us to believe okay they also want to believe in transitory like two years ago and I think that we want to fade, we want the fade transitory and I think we want to fade higher for longer.

43:26That's what they want us to believe. So 50 basis points of those rate cuts for next year in the past couple of months have been priced out and that's how we ended up from three and three quarters in the 10 year note to 4.3. It's all been a reset of Fed expectations that showed up in the term premium. But I think that what's going to happen is this. And once again, the San Fran Fed laid it out for us. I said they produced the best research And I said that for a long time. Just a few weeks ago, they updated their report on where they see the rental components of the CPI. And here's the reality. We can talk about energy if you want.

44:01We can talk about food. We can talk about health care. Nothing is more important than the 33 % share of the CPI that's in the rental measures and 40 % of the core is in the rental measures. So here's the deal. If you get the rental measures right, you're going to get headline inflation and core inflation right. So they did all this re-estimation of what happens. Of course, there's these three-year distributive lags in the rental component. So they still include the high leasing rates when there was no building activity going on in the apartment sector. They're still included in the data, but they're gradually falling out.

44:35And what lies ahead is the fact that we know in real time from the high-frequency data that real-time rents sequentially, end year over year, are actually deflating. But they've yet to forcefully show up in the CPI numbers. So the San Fran Fed, they laid it out on a silver platter for us. They said that by this time next year, that the year-over-year trend in the one-third of the index called rents, OER and actual rents, are going to be flat to negative. Well, holy disinflation, Batman. They just told us that you can lop. We don't know what the rest is going to be doing, what assumptions you want to make about food and energy and autos and clothing and apparel and everything else.

45:16Let's just say that we just say the trend in those areas will remain the same. And of course, if you go into a recession, the demand in those areas will go down and they'll disinflate. But they just told us that we can just lop off three percentage points off the headline inflation rate just from this impact alone. So you're talking about headline and core inflation. Headline inflation going well below 1%, probably half of 1%, core going to or below 1 % in the next year. So there's not a snowball's chance in hell that even the most ardent hawk on the Fed is going to allow real rates to go up that high in the context of an economy that we know is going to be slowing down.

45:57Whether it contracts or not, we'll see. But whatever happens, the output gap is going to be expanding. It should be expanding in anybody's forecast. And they will be cutting rates. The question is by how much? Same before, just to get to neutral. and nobody knows where neutral is, but the Fed's telling us it hasn't moved during COVID. There's a big debate. John Williams in the camp where our star is still going down. Let's just say it's two and a half percent. Just to eliminate the excessive monetary restraint, they got to cut rates 300 basis points. And then what we know from history, what we know from history is that in recessions, the Fed cuts the funds rate 500 basis points to a T.

46:39The only reason they couldn't do it in the last recession is because the starting point was below 2%. So then QE, expanded QE becomes a synthetic way for the Fed to get rates down to zero or even negative. So I would say that if you have a recession view, which I do, I think history will repeat itself because it so often does. And I think that we will head back down to the zero bound. And everybody who says that's not going to happen will be begging for it because it will happen under a completely different set of economic inflation conditions that we have in our hands today. So I think the Fed will be late because they're always late in both directions.

47:17And then they're going to cut hard, as they always do, including Paul Volcker. Remember, he compares, Paul compares them to Paul Volcker. Paul Volcker was not only the greatest inflation dragon slayer of all time, Maggie, he was the greatest interest rate slayer of all time. Nobody in history cut rates as aggressively as Paul Volcker did from the early to the mid-1980s, to the time that he left office in 1986. So yeah, I think rates will come down, come down hard. Lizanne, where do you see opportunity as you look out? Since we do have this sort of uncertainty and this divergence of opinion, how are you considering this?

47:55So I think macro will continue to be a driver more than just on the margin. I think dispersion among equities is likely to stay wider. As I touched on before, Or I think the return of the risk-free rate and the sort of bringing back of price discovery is such that factor-oriented investing, investing based on specific factors and characteristics, probably makes more sense than some of the broader blanket kind of growth versus value sector calls. In fact, leadership in the last, I'll call it year and a half or so, has been more consistent at the factor level than it's been at things like the sector level.

48:41And for now, given where we are in the cycle, we've been emphasizing quality. So a quality wrapper is actually a wrapper around factors that both have growth characteristics and value characteristics. So things like high interest coverage tied into stronger balance sheet with higher cash flow and lower debt, but you don't want to sacrifice the growth side to look for positive earnings revisions, positive earnings surprise. So for now, you want to stay up in quality. There are times when you start to anticipate a turn back up in the economy when you exit the compression cycle and you go into the improvement, the recovery cycle, where you actually benefit from maybe going down the quality spectrum, because that's where a lot of the leverage is to that upturn in the economy.

49:33That's what happened when we got the vaccine news. And you benefited by going down quality, because that's where you got the significant pickup levered to the improvement in the economy. Maybe obvious, I don't think we're there yet. So for now, and my colleague, Kathy Jones, on the fixed income side, their group has also been emphasizing staying up in quality. So this is both sort of an equity view at this point and a fixed income view. Yeah, that's interesting. Someone asking, do you think the 10-year will make a new cycle high? And how important is that into how you're thinking about stock performance?

50:14So our fixed income group thinks that we're pretty close to the high in the cycle. It wouldn't surprise me to see a little bit more of a move up. I think there's a lot of volatility in the fixed income market. I mean, the move index, although down from the highs, has been off the chart. So I think some of the swings can be exacerbated simply by positioning and more speculative money playing around in the yield space, and that has been the case in the past. But I think the fundamentals that typically drive yields don't suggest major upside from here, if anything, starting to see a move down at some point not too far in the future.

50:58David, someone writing in, my question for David would be, what would you answer someone whose opinion is that the equity markets played the recession already in 2022? They priced it in when we had that big sell-off. well uh i think that uh it would the lags would be really really bizarre because although the stock market is a leading indicator um it doesn't lead by like two years and in fact the signal from the stock market to the economy is shortened over time to three to six months. So I think that if that was the case, if the question had validity, I'd say, well, we would have seen the recession already.

51:48But I don't think the recession has started. I mean, you can look at some indicators. I don't think the recession has started yet. So it'd be very weird to say that the stock market priced in something that would have happened so long after the event. I think that what happened was that the stock market initially corrected with a reset towards a new interest rate environment, but didn't really price in the profits recession. I don't think that's happened. So let's talk about what we have on our hands right now. The recession has not started yet. I would appreciate that comment if it already started.

52:22We'd be talking about a new bull market. The new bull market starts when the Fed has cut rates. We're 70 % into the Fed easing cycle, which hasn't started yet. And we're 70 % of the way into the recession when the market bottoms. And the yield curve has positively sloped to 10s by 140 basis points. And the equity risk premium is 400 basis points, not 100. So the math isn't working for you. So I would say that let's take a look and see where we are right now. Right now, JP Morgan did some nifty research showing that the equity market is priced less than 20 % right now for a recession. The market for corporate credit is priced less than 10 % for a recession.

53:06So everybody in the economics community, maybe except for me, and I guess maybe Lacey Hunt and Gary Schilling, everybody is throwing out the recession view and throwing caution to the wind, and so have the markets. So no, I would say the market initially just reset to higher rates, did not reset to what the higher rates are going to do to the economy in the next 12 to 24 months. That's the difference. Hey, Maggie, can I add something with regard to sort of leads and lags and Fed policy? It's not a retort or a counter to what David said, because he was talking about the nature of the market versus recessions.

53:43But it made me think of something. I actually wrote an op-ed in the, not op-ed, which is a column in the FT a while ago about this. If you look at all, I think it's 14 cycles, rate hiking cycles in the history of the Fed as we know it, and you go to the point where they stopped, where they were done raising interest rates, and then you look at the equity market performance over the next six months, over the next 12 months. You can draw an average. You can talk about the averages. On average, the market does this. But there is not a more perfect example of analysis of an average leads to average analysis than that.

54:26First of all, you're talking 14 occurrences. That's a relatively small sample size. The range is massive. We have had six months later, a spread of minus, and I'm rounding, minus 20 to plus 20 in terms of percentage move by the S &P, you go a year out, the range is minus 30 to plus 30. So it points out that there are so many forces that impact how the market behaves. And I think too often there's a, and I can't tell you how many times I've seen the word typical use, like the typical performance of the stock market. And I think by virtue of a small sample size and a wide range, the average actually isn't the path resembling any individual experience because the range is so wide.

55:19So there really isn't anything that is typical. We can talk averages, but you have to be really careful to understand in history there's a wide range around those. Yeah, I think that's a great point, Lizanne, and I'm sure this gets amplified in the world of social media and Twitter that we live in that suddenly gets reduced to a narrative and then extrapolate from there. David, I asked Lizanne this, where do you see the opportunity given your outlook? Well, I think that we're not escaping this interest rate shock without an economic recession a classic nber recession and to say that it's not going to happen because it hasn't happened is like as i sit here in toronto in december it's like saying in december to people it didn't snow in toronto therefore there's no winter and it's just the most ludicrous thing to say that we have this monetary shock and there's not going to be repercussions.

56:24And so I think we're going to have a recession and there's no risk asset class right now that's priced for it. I would say that we were much closer to being priced for it in last October, even though I would argue that we still weren't fully priced for it. And now we're priced for not just a soft landing, but we're either priced for some reacceleration that it's hard to know where that exogenous positive shock is going to provide that or price somehow for this soft landing perfect slow economic growth with no variability uh to perpetuity and uh i don't believe in fairy tales so uh i'm bearish on equities uh and if i was going to be if i had to be long if i had to be in the equity market i'd want to be very uh concentrated on what is the beta of the portfolio what's my uh exposure to cyclicality uh so i I basically would be confined to health care, staples, utilities.

57:24They can pick away a telecom, pipelines. So I'm not saying be zero-weighted in equities. In my own personal portfolio, I'm down at 20 % equities. I'm not zero, but it's the lowest weighting I've had since 2007. Take that for whatever it's worth. I think that I want to buy what's out of favor, what's detested, what's already gone through a huge fundamental bear market that always rallies in a recession. and with inflation coming down. So I like the Treasury market. We're only in an inverted yield curve 15 % of the time. This is abnormal. Time value of money dictates that we should be in a positive yield curve environment, but when we're not there 15 % of the time, it's because the Fed is tightening policy excessively.

58:10And in fact, the only three times historically that we did not have a recession in the Fed tightening cycle was in the mid-60s, mid-80s, and mid-90s. Of course, mid-90s was when Alan Greenspan developed the moniker The Maestro. But you see, the Fed stopped tightening once the yield curve flattened. This Fed kept on tightening into the inversion. And the forecast that worked out the best this year is when I said when the yield curve inverted last summer, I said, watch every Tom, Dick, and Harriet on Wall Street dismiss the yield curve as a relic of the past because they always do. You see, for these people, the yield curve only works when the Fed's cutting rates and steepening the curve.

58:46When they're raising rates and burning the curve, it's like, shh, forget the yield curve. The yield curve is just a signal from the bond market that we're going to have a recession, that the Fed's over-tightened, and it's a matter of just timing. Admittedly, I think it's going to happen in the next 12 months. The New York Fed's survey, the New York Fed's model is 95%. Yann Hatzies is 15%, New York Fed's 95%. Yann Hatzies is 15%, and everybody's latching onto that because who's better than Goldman Sachs? And the Cleveland Fed is at 75 % recession odds. Nothing's priced for a recession. It's tricky with the timing of the bond market, no?

59:24And I'm just going to say, my biggest trade is the long bond. Sorry, what was the last question? Well, the timing's been tricky though because people have been putting that bond trade on, but it's been too early. Well, I know it's been too early, but the problem is that when you go into a recession, it's better too early than too late because by the time it's too late, your head's been sliced off. You know, this is the same conversation we're having in 07. Where's this recession? I mean, bond yields surged into the summer of 07. The stock market, the S &P 500 peaked on October 9th of 07. That day at 1565, I'm giving a presentation at the Fed in Washington.

1:00:01And at the end of it, it was around 5 o 'clock, they said, Rosenberg, you know the stock market just hit an all-time high today. You're talking about a recession. Recession started in December of 07. And you had people like Ed Hyman, for example, who really represented the consensus of economics thinking was soft landing right through the first half of 2008. We didn't know until really people started calling for recession once the recession caused the next leg, which was the crisis, the financial crisis. So I understand the timing is tricky. You know what? Economists are not going to give you timing.

1:00:35It's not our craft. If you want timing, go speak to a technical analyst and they'll show you the ABC waves and they'll show you the 10 day moving average against the 50 day. All I'm saying is that it's out there. I'm not saying it's going to be a 2026, 2027 story. I'm not saying that this is out in the next five years. In 07, beginning of 07, I understand that I was early, early, early, but I'm going to tell you something, okay, Maggie, for my own personal career by 2008, nobody was saying I was crazy early anymore. and all the people calling me a skunk at the picnic on the sales desk couldn't wait to take me out to see their clients.

1:01:09I can't believe anybody called you a skunk, David. I find that hard to believe. We're almost out of time, Lizanne. Just want to ask you any feeling about U.S. versus the rest of the world? We have seen on an equal weighted basis non-U.S. stocks performing better than U.S. stocks. There's been such a cap bias in the U.S. indexes, which I'd like to see ease. I think we could benefit from some broadening out and moving down in performance and seeing equal weight within our market perform better. That has not been the case, but that's one of the things that I'm looking for. But if you're an active investor and you're more focused on sort of equal way conceptually non-US has done well relative to US this year.

1:01:57All right. We happen to leave it there. I can't believe we just flew by with all that time, but it was fantastic to catch up with both of you. Thank you so much for sharing your insights and what's been a really tricky macro time for everyone. Thank you. Thank you. All right. Next up in the series, a fantastic interview with Larry McDonald and Luke Groman. You are not going to want to miss that. And of course, we'll be back with the Daily Briefing at 4 p.m. Hope to see you then. Thanks, everybody. Take care and good luck out there.

1:02:51With just a few clicks, you can register and start practicing with their free and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved. And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments. S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, Forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus500.

1:03:24With over 20 years of experience, Plus500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus500. It's trading with a plus.