The Recession Plot Thickens ft. Mikael Sarwe

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0:35Hi, everyone. Welcome to the second installment of our special series, Crash or Boom? How to Profit from What's Coming. So Raul kicked things off with his overview of what he expects over the next eight to 10 months. And not surprisingly, he's bullish. He thinks the recession that everyone's been waiting for is already here. It already happened and may actually be ending. He's not worried about inflation. Instead, the big issue for Rao is the ballooning debt and the government's need to finance it. That debt dynamic is core to his belief that tech and crypto offer the best opportunity in the next year.

1:09But we've got some pushback in the comments, as we expected. William M. pointed out that Rao may be in the minority. And many of you raised issues about commodity prices and the impact of China, to name just a few. So to drill down on some of these points and give us their view on crash or boom, I'm joined by my colleague Andreas Denelarsson and Mikael Sarovay. Andreas, take it away. Thank you so much, Maggie, and great to see you as well, Michael. You recently wrote a piece called The Plot Thickens, and it relates to the discrepancy that we've seen between the gross domestic product and the gross domestic income in the US.

1:50One is pointing to a recession, the other is pointing towards maybe even above trend growth at the current juncture. So what do you make of this crash or boom question initially here? Are we already in a recession? Yeah, it's a very interesting question and there are indicators that point that way, I would say. However, of course, markets and economies tend to follow GDP numbers and unemployment numbers, and they're not there yet. And the debate on the gross domestic income versus gross domestic product is an interesting thing in that sense, given that normally those should basically be the same, and right now they're not.

2:30If we look historically, it's been the case that, for instance, in the financial crisis, you saw a weakening in gross domestic income before GDP. So it was a leading indicator back then. It was also a leading indicator, I would claim, in the early 90s. And it rhymes a lot better with many of the other indications of a recession. As you can see in the senior loan officer survey with credit tightening a lot, you can see it in filings of bankruptcies piling up in the US. You can see it nowadays also in job openings falling quite severely in the US with layoffs at the cyclical high and so on. So to me, it is an indication that maybe GDP numbers are overstating how good the economy is doing right now.

3:21And as I said, it has tended GDI to be a leading indicator in the past. Michael, in full transparency, you are my former boss from Nordea Bank. and we've worked together on building macro models throughout the years. And I sincerely think that you have the best model package on earth when it comes to forecasting gross domestic product developments across the globe. So if we look at your GDP model for the US right now, it basically screams recession, doesn't it? I think we can get it up on the screen here. Yes, it does. And it has been doing so for a while. and if we look back in the past, basically it has historically never been wrong when it's pointed to recession.

4:06We of course also know that GDP numbers and for that matter labor market numbers as well, they are a little bit difficult at turning points. There tends to be quite large revisions. So we'll see how this plays out. I mean I tend to follow my models very closely And right now, it's clearly so that the U.S. one has been wrong. But on the other hand, if we look at sort of my Swedish one or my European one, they are continuously spot on in terms of pointing to recession. So I guess the plot has taken. Yeah, it has indeed. And if you look at the current discrepancy between your model and the actual outcomes in the gross domestic product in the U.S.

4:50economy, are there any reasons to sort of believe that the U.S. economy is resilient relative to what we've been used to and what the model sort of used to forecast based on? Yeah, I mean, of course, you should always think that your models can crash. And there could be periods where other factors are important. I guess one thing right now that could be of importance is both the old stimulus checks from COVID, how much money actually was left of those heading into 2023. And then secondly, in some sense, also the Inflation Reduction Act and kind of the policy effects from that. Those are two reasons that maybe means that the economy is moving along more smoothly than my indicator is pointing to.

5:45And on top of that, I guess, if you add a little bit of what I've been calling the nominal illusion, in terms of looking at other economies that we see that volumes are falling in many countries in terms of industrial orders and so on. It's not true for the nominal side because of inflation. And of course, companies have a bottom line which is nominal. And as long as the bottom line looks okay, I think perhaps that is another explanation why it drags on this time. I can actually bring up a chart on that exact effect from the Inflation Reduction Act. I've relabeled it to the Inflation Refueling Act instead.

6:27Watching the developments in the U.S. economy right now. It's a chart showing the construction financing across various subsectors in the manufacturing sector. It's chart number three. and the financing for manufacturing construction is basically through the roof over the past, say, 8 to 12 months here, likely as a consequence, among other things, of the IRA and also the Chips and Science Act. So without that stimulus from the public sector, would the US be in a recession right now? Is that a fair assumption to make, Michael, based on the deficit that we see in the US now compared to peers as well?

7:08I would guess so, that that would be the case. Then I guess another point to make here is that, I guess, as many have pointed to as well, we have a housing market where the existing home sales market is more or less dead because you basically can't move, can't afford sort of higher interest rates. On the other hand, it's still the case that the interest rate on the outstanding stock of commodity loans are quite low. So in normal circumstances, rate hikes of the significance we see now should have started to affect the economy, but it seems that it might be a longer lead this time. Of course, normally if you take monetary tightening and look at the maximum negative effect on any economy, it tends to be sort of one and a half year out in time.

7:59And of course the Fed was still hiking rates fairly recently. So I would still think that the lagging effects of the monetary policy tightening will be with us far away into 2024, in my opinion. If we look at the cyclical components of the US economy relative to the stickier components in, for example, the service sector, in the leisure sector, in the healthcare sector and stuff like that, where do you find the manufacturing versus the service sector to be at this juncture in the US economy? I know you have a tremendous chart on truck transportation chart 4 that we can bring up in this discussion.

8:42yeah it is i think in general uh looking at various type of of labor market data clearly it's been the case and it has been the case since after the covid the problem started to disappear that there's been a shift back to services uh clearly uh after the huge increase in in more goods consumption before that and clearly the labor market has also been continuously strong. However, there are a lot of indicators, cyclical indicators of the labor market where we're starting to see a change. This is a truck transportation cost. Clearly, it's affected by the yellow bankruptcy, but still it tends to be a very clear cyclical indicator when employment here starts falling.

9:29The same is true with temp jobs that we've seen falling now for a number of months. So looking at these indicators and looking at kind of the service versus goods side and kind of the ISM and ISM non-manufacturing if you want. It still looks like services are keeping up. However, with the monetary tightening, I would suspect that those things are now turning the other way, while perhaps the manufacturing cycle looking at the ISM could be bottoming at some point here. And what the net effect there will be for markets is quite tricky to say. I would say still, of course, if you look at the service sectors in the U.S., it's like 85 percent of the economy.

10:10So if that slows down the way I expect, that's an effect of higher interest rates and cash flow effects on that down the line. Then that would be more important. But markets often have a tendency to look a lot at manufacturing data as well. Hey, everyone. We're going to take a quick break right now 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo.

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11:36Michael, you're obviously based in Stockholm, Sweden, and I guess Sweden is one of the most interest rate sensitive countries on earth. I think that's fair to say, also given the exposure to variable interest rates in mortgages, etc. So as international investors, is there anything that we can learn from the developments that we've seen in the Swedish economy, say over the past one or two quarters here. Yeah, I think so. I mean, it's been so in the past that Sweden has relatively often been a little bit of a canary in the coal mine for the global economy. So when Sweden is running into problems, which we have been doing now for a while, then it's usually an early sign that you'll see other parts of the world going the same way, kind of like Germany is doing now and what have you.

12:25And of course, one part of that is the small open economy that Sweden is, with a large export sector that fairly early picks up on trends turning either positively or negatively. And then the second part is what you alluded to, which is households having higher debt here than elsewhere, and a lot of variable rate loans, particularly on the mortgage side. So when we see rate hikes here in Sweden, it tends to affect the house prices quite directly and house prices then leading to also affecting consumption. So of course what we have been seeing in Sweden is a clear slump in personal consumption over the past year or so and in retail sales.

13:12And what we now are seeing is basically a full stop on more of the construction side, where building permits have plummeted and we now see clearly a much lower activity. On the export side, I think also it's important to note that Swedish companies that are helped by a very weak currency still now see in various business services that the water intake, the new water intake, is deteriorating quite rapidly. while they still have fairly good order books with old orders basically stemming back from the COVID years. So I think the fact that Sweden is in a recession and will continuously be in a recession into 2024 is to me an early sign that the rest of the world will follow.

14:01I think we can bring up a chart on that exact new order survey from Sweden. chart number six, and it doesn't look pretty, to say the least, with recessionary vibes since late last year, and obviously also given the forward-looking nature of this survey with recessionary vibes into next year. If you look at the German economy, obviously one that is tracked by many also in the US, Michael, what do you make of the current state of affairs in Germany and the recession risks in the eurozone overall are we already there Germany I think so I mean unemployment bottomed I don't know exactly but maybe six months ago something and has increased since GDP is negative in Germany year over year even though it's small negative I guess the whole euro area isn't really there yet but clearly Germany is and of course in Germany we see similar signs as in Sweden but with a little bit of a lag in terms of the real estate marking moving into problems and also here and nowadays building permits plummeting in a way that basically is telling us that construction will be basically dead for 2024 and so Germany is really following a lot of what we're seeing in Sweden we've seen quite weak order numbers out But the IFO that started to bounce up as the energy crisis was getting less severe has now turned down again.

15:35Following, I would say, once again, the monetary tightening rulebook, i.e. with kind of one to one and a half years lag, or rather one half years lag, you should expect the monetary tightening to hit the economy and particularly start to hit the service sector, which you're also starting to see now in PMIs around Europe. Yeah. One of the key themes in our campaign over these two weeks is how to profit from this crash or boom binary scenario, Michael. And I received the latest copy of Bank of America's fund manager survey today. They conduct this survey among money managers each and every month.

16:16And they, for example, ask the managers for their current positioning relative to benchmarks. and I noted that Europe is truly out of fashion again in this survey while the US is among the top picks. So when we talk about the US economy being more resilient than Europe, it may already be priced in, at least if we listen to this fund manager survey. So what do you make of the positioning also with your sparing partners in Northern Europe? Is the US still the consensus long story out there? I think so. And I guess talking about Europe and saying it's easier to have people believe in you when you say that Europe is heading into recession compared to saying the same about the US.

17:04and I think that also is clearly what you see in positioning and of course Europe, if you look at Forward PE on the median company in Europe and the median company in US, I trying to scale away these magnificent seven then Europe is looking cheap, very cheap compared to history but of course the reason is that everyone believes that or everyone most believe that Europe is in a recession while almost everyone believes that the U.S. will not be. And then you end up with that type of position and that type of relative valuation in a sense. And I guess what I'm saying is that I expect the U.S. to follow Europe down into recession.

17:48And then this quite large valuation difference compared to history perhaps looks too large. Yeah. Fair point, Michael. And where does China rank in all of this? I went to the US, was it three, four months ago, with my front page of the slide deck stating that Chinese assets are the cheapest on earth. And there might be a reason why they're the cheapest on earth. But how do you rank China in all of this also given what's ongoing in Chinese real estate? I mean, looking at China and sort of my view was heading into 2023 that when we were starting to see this reopening story, that that would falter, which it to some extent has done now, partly because of the property market and the real estate market and very much for domestic reasons.

18:44But I guess also in a sense which you can see now, and that is that imports from China to the US has basically slumped, which seems to be at least partly a political story, I would assume, which means that to my mind, it would be difficult to sort of believe in this reopening story fully. and I guess now that has turned out to be true at this instant. I mean, that doesn't mean that things will continue to look that way and of course now we are seeing a lot of measures being taken. So I've been cautious about China, which has been correct in a sense, but now everyone is getting very bearish on the other hand.

19:28So maybe I think it's time to scale back on that bearishness and hawkishness because of everyone else. And I have to note that what we've seen recently is the Bank of China adding a lot of liquidity through their open market operations. And when we've seen that in the past, it has at least temporarily created a cushion for the equity market. And equities have tended to go up a little bit during those periods in China. It has a very strong link between what the PBOC is doing with these open market operations and the stock market. So that makes me a lot less negative than I was if you go back three, four months on it.

20:10And we'll see about that. If we look at the current price developments in oil space in particular, but also in broader commodities, we've seen a tendency towards higher prices over the past couple of months now. And it may be related to a rebound in China. and we're not fully sort of certain of that story yet. But what do you make of this spike in commodity prices, given that we are, if not amidst that, at least on the verge of a recession around the West? No, it looks a little bit odd, I have to admit, and particularly with my more negative tilt. But of course, prices are what they are, and oil prices are booming here.

20:56And it's also a little bit different to see in terms of the balance of demand and supply right now on the oil market. But so whether how much this is speculation or not, we will see. But it clearly doesn't rhyme fully with my more negative tilt. However, of course, my negative tilt is right now more tilted towards kind of service sectors and consumption sides of the economy, perhaps rather than the manufacturing side. But anyway, so it looks a little bit odd, but I guess, and the sort of side effect of it will likely be that right now, when a lot of investors and a lot of economists are expecting that we basically have passed the peak now in terms of Fed Fund's target rates, and for that matter, I guess the same is true what the market is counting for the ECB.

21:47I guess this is something that could change that because what will happen now is, of course, on the back of this increase, we will see all the classic price components of ISMs and PMIs shooting up again and perhaps shooting up quite markedly. And that is something that normally, I guess, the bond market and central banks do not like. 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.

22:21I had a tremendous discussion with Hugh Hendry, the former hedge fund manager at Real Vision, a couple of months ago on how to tail hedge for a recession in the US. And he was of the view that calls on TLT, so the far end of the yield curve in the US, made sense also from a price perspective at the point, if you wanted to hedge yourself against that recession risk. But given the price spikes that we see in oil space, given the lack of true progress towards that 2 % inflation target, can one hide in bonds into such a recession in the US here, Michael? Is it as safe as it used to be? It's less safe, let's say it like that.

23:05And I would have agreed with him. And I mean, if I go back here and, you know, think about what I was, what my focus was then, I back then guessed that by now it would be more clear that also the U.S. was entering a recession and that that would lead to a clear bond rally. However, as time has progressed, you know, I've come to the conclusion that that's probably too early, which it has been so far. and clearly now a lot of my leading inflation indicators and you know a lot of them I mean they're not looking as benign as they did before I have a US CPI model that looks six months out or something and for the US and basically it picked the development very well on the way up and very well on the way down now it's saying that it's not going to improve anymore We're going to have US CPI at above 3 % also the early parts of next year.

24:02And that makes, of course, a more difficult situation if you want to be a bond bull. Clearly, at the end of the day, however, if we get a more severe recession, that will definitely seal the deal for bonds, I think. But for now, what I've been saying since before the summer is that the risk and sort of the trend for the bond yields would continue to be up. because central banks are quite clear with the idea that whatever happens in terms of where the peak is in policy rates, rate cuts are very, very far away. And as that is such, and then looking at today with all the inflation indicators, perhaps signaling that it's not going to be as easy to get inflation down next year, Then you end up with the risk that we should see new highs on the U.S.

24:5110-year yield again here before, if I'm right, the recession scenario comes into play perhaps around year end or something. Yeah, I basically lean the same way. And earlier today, we got the monthly survey from the NFIB, basically a survey conducted among small and medium-sized companies in the U.S., 80 % services-based-ish. And the price plans ahead actually re-increased in the survey again. So when they look three, six months ahead, the CEOs of these small, medium-sized companies, they actually expect both compensation of employees and price plans to be a tad higher than they did just a couple of months ago.

25:36It may be related to the commodity price spike, but it basically rhymes with what you're saying, Michael, that we will get at least a local bottom clearly above 2%. in US inflation. So in relation to the market pricing right now of the Federal Reserve, no one believes in a hike here in September, but there's still, I'd say, a decent chance priced in for another hike this year. But then next year, cuts, cuts, cuts, right? So what do you make of that cocktail? Is it too early to price all of that in given the recession risks? I think so. And I think what we will continue to hear from the Fed and for that matter from the ECB is that they will disagree with the discounting rate cuts next year and basically sending the signal that 2024 we will be on hold.

26:25And so we need to see a lot more evidence of the recession and particularly the US recession before you can embrace a more bond-friendly environment and a more normal cyclical bond rally. I mean, if you look at macro, So if you build the macro models on kind of long yields or 5-10 year yields for the US and look at it right now, with inflation where it is, with the labor market where it is, with wage growth where it is, with the Fed where it is, you should expect bond yields actually to be clearly higher than they are today. So let's call it the macro magnet is still for higher yields. So as long as the economy moves along nicely here, yields should continue to climb.

27:11we need to see those clearly higher unemployment numbers, I would suspect, before we get into a more bond-friendly environment. Yeah. If we look at some of your forward-looking employment models for the US, I know that you've typically used job openings as an early indicator of non-farm payrolls further down the road. What do you make of the job opening gauge right now, given that we've entered a slide from a very, very, very elevated level of job openings? Is it still a feasible indicator to watch? I guess we will see. I think so. Because, yes, we entered it with a very high number of job openings, but we also entered it with a very high employment to population ratio in the US.

27:56So, of course, that rhymes. So the starting point is one where we've had a lot more people employed versus the population than historically. So in that sense, even if it's dropping from a high level job openings, it should still have an effect as far as I can see. And particularly now when we're also starting to see layoffs actually increase in the challenges statistics or data, I think so too. And what I find very important right now and which it has historically been, And as I see it, a very important coincidence indicator is that households within the Consumer Confidence Survey now is signaling that it's starting to get harder to get a job.

28:41So the so-called job easy versus job sort of get component is now moving in the wrong direction. And that has historically been a very, very strong indication that unemployment is about to start rising. If we look at the risk of rising unemployment relative to the equity market, one of the discussions you and I have had over the course of the past year actually is whether the actual timing of rising unemployment is the actual timing of a new sell-off in equity markets. What do you make of that comparison at this juncture? is it feasible to expect that markets will sell off once unemployment actually kicks in?

29:28Yeah, that would be my guess. I mean, if we go back a bit and look at the bear market that was in 2022, I guess that was, compared to history, the odd bear market, because it happened when the economy was still doing fine.