In recent years, the US economy has seemingly achieved an incredible feat. Even with persistent inflation and rising interest rates weighing on consumers and businesses nationwide, and wars in the Middle East and Europe weighing on global growth, there is little sign of an American recession.
Against this backdrop, and despite headwinds, US stocks have soared. Wall Street bulls argue that this is all an unusual but not unprecedented economic “soft landing,” driven by consumers and businesses now structurally more resilient to higher borrowing costs. Some even claim that we are living in a period of American exceptionalism in the rules of the economy and the market.
“The only difference is that the size of this bubble that’s going to burst is bigger than we’ve ever seen…”
But for Mark Spitznagel, co-founder and CIO of private hedge fund Universa Investments, all these ideas are just attempts to find a story to explain how “it’s different this time,” when the reality is that history tends to is repeated.
“It’s not different this time, and anyone who says it is, really isn’t paying attention,” Spitznagel told Fortune, adding, “the only difference is that the size of this bubble that’s going to burst is bigger than what we have ever seen…”
Spitznagel has claimed for years that the Federal Reserve helped pop the “biggest credit bubble in human history” with years of loose monetary policy — and warned that all bubbles eventually burst, earning him the reputation of a “permanent bear.”
Intense anxiety
Even now, with most Wall Street experts appearing bullish this year, the veteran hedge funder worries about the economy. He believes the negative effects of the Fed’s monetary tightening at a time of elevated levels of corporate, consumer and government debt have simply been delayed.
We’re stuck in a short Goldilocks zone as higher borrowing costs permeate the economy
According to Spitznagel, whose patented strategy, called tail hedging, seeks profit, the signs should not be ignored: “This is an unusual tightening process, peaking process, reversal process, going into recession. I’d be surprised if we’re not in recession by the end of the year,” he said.
The tinderbox economy
Not long ago, many Wall Street analysts shared Spitznagel’s negative predictions, warning of an impending recession. But most no longer see an immediate risk of financial or market collapse.
However, Spitznagel argues that the current, relatively stable economy is “not inconsistent” with the lagged effects of Fed tightening. “It takes time for the higher cost of debt to reach the system,” the hedge funder explained.
We are stuck in a short Goldilocks zone as higher borrowing costs permeate the economy, but that will soon end. The term describes the ideal state for an economic system. In this perfect state, there is full employment, economic stability, and steady growth.
Total global debt reached a record $315 trillion in the first quarter
Spitznagel says the Fed has created a “Tinderbox” economy (a situation in which a crisis can go off at any time, like a bomb) by keeping interest rates near zero and bailing out the economy with quantitative easing – a bond-buying policy with mortgage and US bonds – as long as it did. These policies created an environment where businesses and consumers borrowed heavily to invest and spend because it was cheap, he says, and that led to high levels of debt and artificially kept alive unsustainable business models.
Record debt
According to him, US non-financial corporations currently had a record debt of $13.7 trillion in the first quarter of this year, according to data from the Fed. And total global debt hit a record $315 trillion in the first quarter as well, according to the Institute of International Finance. Much of that debt is public debt, but Spitznagel worries about sustainability there, too.
The U.S. national debt topped $35.1 trillion this summer, and the U.S. debt-to-GDP ratio is now expected to reach 116 percent by 2034, according to the Congressional Budget Office — higher than what was seen during the during World War II. The situation looks similar abroad.
With the Fed keeping interest rates high for years, Spitznagel fears the impact of rising debt costs on companies, consumers and governments around the world will soon mount.
Spitznagel’s favorite index
The key indicator that Spitznagel watches for signs of an impending recession is the yield curve, which plots interest rates on bonds, usually U.S. Treasuries, of equal credit quality but different maturities. When the yield curve inverts, meaning that short-dated bonds offer a higher yield than long-dated bonds, it historically indicates that a recession is imminent.
Each of the last eight U.S. recessions dating back to the 1960s came after the 10-year Treasury yield fell below the 3-month Treasury yield, for example. And currently, the US 3-month yield is higher than the 10-year yield for 22 months, the longest reversal in history.
However, the inversion of this yield curve is not the true recession indicator, according to Spitznagel, it is the return to normal, or reversal. “It is one of the most important indicators [ύφεσης] that exist, the inversion of the yield curve – look at the historical data,” he said.
Historically, it has taken almost a year, on average, after the first inversion of the 3-month/10-year yield curve for a recession to begin. But according to Spitznagel, it only took 66 days on average from the time the yield curve inverts for the economy to break even, Reuters first reported, citing data from Jim Bianco, a strategist at Bianco Research.
Doomed to a stagflationary future
Eventually, after that bubble bursts and a recession sets in, Spitznagel fears that excessive debt in the global economy and “money printing” by the Fed will lead to a period of low growth and high inflation.
He argues that the Fed will be forced to “do something heroic” to save the economy and markets when they crack, but that will only be a “Pyrrhic victory.” Cutting interest rates, reviving quantitative easing or even launching new, untested stimulus efforts will not be enough to prevent serious pain for consumers and investors. And when the Fed’s efforts begin to pay off and help stabilize the economy, stagflation will become a problem.
He also fears that a recession is coming, that the stock market bubble will burst soon, and that stagflation is a long-term risk: “I don’t think we’re headed for the Great Depression. I’m not a guy who calls for the end of the world. I just don’t think we’re going to like the things that have to be done to save this artificial, massively manipulated bubble that we all live in,” he said.
Source OT
#Markets #Biggest #market #bubble #poised #burst
