|Contrary Investor also compared current time to 1994|
From The Bottom To The Top - A Look Back...As you are most likely well aware, probably the chief debate among investment/economic strategists at the moment is over whether what we face as a domestic economy looking out over the next 12 months is a “mid-cycle slowdown” or an outright recession. And the comparisons we see drawn in this important dual outcome possibility by those choosing sides, if you will, are the monetary tightening cycle periods ended in 1995 and that of 2000. Very quickly, as you’ll remember, 1994 was a rotten year for stocks and bonds as the Fed was in the midst of “taking back” the special monetary easing engaged in from the early part of the decade through 1993. At the time, the Fed was essentially reliquifying the US banking system post the early decade LBO and high yield debt blow-ups, as well as the S&L debacle. Late 1994 and early 1995 saw the US economy slow in terms of GDP growth quite dramatically, but an official recession was narrowly averted. The economy slowed and then reaccelerated into 1995, simply never looking back after that point.
In contrast, the final monetary tightening event early this decade came in June of 2000. And although many believed the economy was simply slowing post the peaking in dotcom related tech spending, within nine months we found ourselves at the doorstep of what was to become an official recessionary period. Although this current debate between the “mid-cycle slowdown” and "full-blown recession to come" crowd has been ongoing for some time, we thought now might be an appropriate time to provide what we hope is a bit of dispassionate perspective surrounding the macro conditions seen in the 1994 and early 2000 periods. For we now again face the end of yet another monetary tightening cycle period and, at least from our perspective, as we have written about extensively as of late, we also believe we face a slowdown in GDP growth directly ahead. For now, the final outcome is unknown in terms of the slowdown versus recession debate. As we have stated many times in the past three to four months, it sure seems that the final real world outcome to this now academic debate in good part rests on the fate of the residential real estate cycle. There is simply no question that the recession of 2001 was driven by a collapse in corporate capital spending (tech and otherwise). This go around, the focus is squarely on the US consumer.
Basically in no particular order we’re looking at a broad series of data points in the following table. We’ve tried our best to get as close as possible to picking up year-end 1994 values as well as 1Q 2000 period end values. In one sense, we’ve tried to look at a bottom to top cycle. Early 1995 being the initial reacceleration period for US GDP growth and early 2000 being a peaking in both GDP growth and the US equity markets (as of 2Q 2000, year over year real GDP growth peaked at a level unsurpassed since that time). Let’s have a look.
We promise we won’t bore you to death with a lot of commentary. Although no one knows what lies ahead, there are certainly some key differentials between conditions in 1994 and 2000 relative to the present. Growth, or lack thereof, in consumer credit stands out like a sore thumb. You already know this has been one of our key focal points for some time now. Interestingly, current headline CPI is higher than either of the previous two periods under study. Because of globalization, in our minds a brush with stagflation is a greater probability today than during or near either of the two prior periods. Macro systemic and specific household leverage figures simply speak for themselves. These should be a surprise to no one. You already know that payroll employment growth in the current recovery, so to speak, is one of the worst on record. Old news, but still very visually different than either 1994 or early 2000. What is a very noticeable differential of the moment is the shape of the yield curve. We’re dead flat (actually inverted out ten years) at the moment, but in both 1994 and early 2000, there at least was some slope to the curve, albeit modest in 2000. The curve of the moment is putting the hurt on financial companies, key provocateurs of what is the very important US credit cycle.
What these numbers tell us is that relative to both the mid-cycle slowdown period of 1995 and the prior to official recession period of early 2000, current circumstances can collectively be characterized as presenting a greater sense of imbalance. Greater leverage related pressure on US households. Much greater reliance on the foreign community (ownership of US financial assets) to "fund" the US economy. And an economy more dominated today and driven by macro credit cycle (financials as a % of the SPX) dynamics. Crazily enough, as per the numbers above, it sure seems the domestic US economy was in much better shape in early 2000 than is the case today. Is this really the picture of a foundation on which a follow on US economic expansion will occur post a simple and painless mid-cycle economic slowdown? Again, anything can happen, but current circumstances relative to prior cycle dynamics tell us to be on guard. For now, it's too early to call an official US recession. But it's also too early to suggest a temporary mid-cycle slowdown will automatically turn into something much darker. In the final analysis, the equity and bond markets will give us the ultimate report card in terms of just where the US economy is heading. All we have to do is watch and listen.
Lastly, it seems common sense that if indeed only a simple mid-cycle economic correction and nothing more lies in our future, we’d expect many of the imbalances or outliers, for lack of a better term, you see above to grow ever larger. For that to happen, we believe the Fed has to “blink”, if you will. And that means not only dropping the rate increase routine pronto, but also continuing the relatively high level of open market operations the liquidity driven financial markets have come to expect.