I spend a lot of time asking questions. I don’t always have answers to these questions but I think it is critical to ask them. Think about how the consensus might be wrong or, more importantly, how you might be. Question the narrative and try to determine what’s important and what’s not, who you can ignore, and who merits your attention. Here’s a short, nowhere near complete, list of things I’m thinking about today. 

What is a rolling recession? I’ve been hearing this a lot lately, that the economy is in a “rolling recession”, meaning I suppose that parts of the economy are contracting but the overall economy is still expanding. I’ve got news for all the “rolling recession” folks out there – that’s a normally functioning economy. There are always parts of the economy performing better or worse than other parts. There’s no such thing as a “rolling recession”. I think what the people who use this term really mean is “I thought we’d already be in recession by now and since we aren’t, rather than admit my mistake, I’ve made up this term “rolling recession” so I don’t have to.” Here’s a tip for all you economic soothsayers. If you don’t try to predict the future you won’t have to make stuff up to feel better about being wrong. If you insist on continuing to try and predict the future, when you’re wrong – and you will be – then man (or woman) up and admit it. It’ll make you a better investor, I promise.

Is the Fed responsible for the drop in the inflation rate? In June of 2022, the year-over-year change in the Consumer Price Index was nearly 9%. By June of this year, it had dropped to 3.1%, almost entirely a result of falling energy prices. Crude oil dropped from $123 to $70 and natural gas from $10 to $2.50 (yes, I’m rounding). During that time the Federal Reserve raised the Federal Funds rate from 1.25% to 5% and it is tempting to find causation there. But did the Fed’s rate hikes really have anything to do with the drop in energy prices? The same could be said about QT. Did the reduction in the Fed’s balance sheet (reduction in bank reserves) really have anything to do with natural gas prices dropping 75%? And if the Fed’s actions aren’t the cause of the lower inflation rate, what does that imply about future policy? And inflation? 

What is Bidenomics and is it working? The first thing to note is that large parts of Bidenomics could easily be called Trumponomics. Both administrations have used tariffs, export controls (mostly against China), and Buy American policies to, supposedly, bolster domestic industries. But the Biden administration has raised the use of industrial policy to a level not seen in decades with subsidies for semiconductors, renewable energy, and infrastructure among other things. Government spending is part of the GDP calculation and so government-directed investment (spending) will show up as “growth” as these projects get built. But the “boom” in manufacturing construction that we keep hearing about amounts to just 0.6% of GDP; are expectations too high? And what happens when the spending is done? Will the projects funded prove to be an efficient use of capital? What private sector projects will not happen because they don’t fall into a politically favored category? History provides little – actually no – evidence this economic approach will be successful in creating lasting growth. Unfortunately, it is one of the few areas of bipartisan agreement these days. Maybe that’s because policies like this are beneficial…to politicians. 

Are we already seeing the results of government-led investment? Electric vehicles are the most visible product of government subsidy-induced investment. And it doesn’t seem to be going that well. There’s a 90-day supply of electric vehicles sitting on car lots and only 54 days of gas-powered vehicles. The Field of Dreams approach to investing isn’t working. Maybe someone should have consulted auto buyers before spending billions and billions of taxpayer dollars to fund a transition that no one seems to want. Someone wake me up when EVs achieve a 15% market share (6.5% now). 

Is the inflation problem really behind us? The dollar index fell below 100 this week, a 13% drop from the 114.75  high it set in late September last year. One of the odd things about last year’s “inflation” surge is that it came with a strong and rising dollar. Inflation isn’t the rise in prices. Inflation is the devaluation of your money; rising prices are the effect. So, if the dollar instead rose in value while prices rose, was that inflation? Actually, no. And I think that is pretty important to recognize. If the rise in prices didn’t have a monetary cause, then it probably doesn’t have a monetary solution, which brings us back to the question above: Did the Fed’s policy changes actually reduce inflation? Or were the rate hikes coincidental with a process that would have happened anyway? What worries me is that everyone seems to think that the “inflation” problem is behind us now. And if the price hikes were mostly about supply chain issues then they may be right. But a falling value of the dollar is the very definition of inflation and if it continues, prices will probably rise again. What if the inflation problem hasn’t been solved but instead is just getting started?

Could the yield curve steepen back to normal (positively sloped) without a recession? The 10-year/3-month Treasury spread has been inverted since last year and that has been a reliable predictor of recession in the past. The timing is variable but in the last 4 recessions, the curve inverted, on average, a year before the onset of recession. Using that as a template, a recession would arrive near the end of this year. But is it possible that we could see the spread normalize without a recession? Well, there isn’t any precedent for an inversion of the current magnitude being corrected without recession in the US although we did have one inversion (since 1960) that didn’t precede recession.

That was during Operation Twist in 1966 when the Fed was selling short-term and buying long-term Treasuries. That may be an important distinction. The period since the 2008 financial crisis has seen the Fed expand its balance sheet through the purchase of Treasuries and MBS (QE, buying long term). The only experience we have with an inverted curve in that period was in August of 2019 with recession arriving just 5 months later with the COVID shutdowns. But I don’t think anyone believes that inversion predicted the COVID recession so that doesn’t provide much insight. Has QE distorted the Treasury market so much that the yield curve inversion is no longer useful as a recession indicator?

Has widespread knowledge of the yield curve made it less useful as an indicator? I’ve brought this up before and Campbell Harvey, who first formally recognized the importance of the yield curve as a recession indicator, has too. To make this more general, how much have modern communications methods affected the functioning of the market? I tend to think the answer is a lot but that is based solely on my own experience (which isn’t inconsiderable at 40 years in the markets). There is a lot more information widely available today than there was when I started doing this but “information” is not the same as knowledge. Has information availability changed investor behavior? I don’t think there is any doubt about that. If everyone knows that an inverted yield curve precedes recession then they will sell sooner than they would have if they didn’t have that information. And some investors will sell sooner yet, assuming that since everyone else will act on this information, they need to act even sooner to get ahead of the crowd. If nothing else, I would expect the lead time from inversion to recession to lengthen. If you want to do anything tactical in today’s market, you better learn how to play Keynes’ Beauty Contest. 

When will “excess” COVID savings really be used up? I have read repeatedly over the last year that the excess savings built up during COVID is gone, especially in lower-income households. It wasn’t true a year ago when I first read it and it wasn’t true a week ago when I read it again. I don’t know why this is so hard for people to grasp but the savings rate is still positive (4.6%) and real disposable personal income is up 4% year-over-year. Every major bank from Bank of America to JP Morgan has said that checking account balances, from the smallest to the largest, are still significantly higher today than they were prior to COVID. Wages are rising faster than inflation now for even the lowest quartile of earners. COVID savings may be getting shifted around, from bank accounts to money markets to TBills, but it isn’t being spent down. 

Should we be buying 5-year TIPS to lock in today’s relatively high real yields? From 1928 to 2022 the annual real (inflation-adjusted) return of the 10-year Treasury was 1.88%. From 1973 to 2020 it was 2.63%. From 2013 to 2022, the real return was -1.91%. Because even the real yield curve is inverted today, you can buy a 5-year inflation-protected bond with a real yield of 1.7% (versus 1.5% for 10 years). A week ago, the yield was over 2%. Since 2003 the 5-year TIPS yield was only higher than that for a brief period in 2006/7.  While everyone is so focused on short-term cash investments, like TBills, maybe we should be thinking longer term.

Joe Calhoun