By Hank Tucker
Less than two years away from a deep but brief recession caused by Covid in 2020, economists have already turned their attention to the next. Gary Shilling believes such a thing could be here by the end of 2022, boosting bond prices and threatening stocks.
The US Federal Reserve is set to raise interest rates at least three times this year, beginning the 13th round of credit tightening since World War II. Recessions followed 11 of the previous 12 cycles – the only “mild landing” when interest rates rose and then fell without a recession came in 1994, so if history is a guide, it’s not a question of whether but when the recession will “hit”.
Although US GDP grew by 6.9% in the fourth quarter of 2021 compared to the previous year, excessive inventories and a slowdown in retail sales indicate that the contraction of the country’s economy could quickly come to the worst case scenario. .
Stimulation of growth
“We are already seeing a slowdown in the growth of the economy in the first half of this year,” said Shilling, chairman of New Jersey-based consulting firm A. Gary Shilling & Co. and former chief economist at Merrill Lynch. “If one takes into account an impending Fed squeeze, I think one could bet on a recession that starts before the end of this year.”
Stocks accumulated 4.9 percentage points of fourth-quarter GDP growth, with Target and Walmart combined stocks hitting historic highs at the end of 2021. But with the consumer climate at its lowest level in more than a decade, With retail sales down 1.9% in December, stores may need to cut orders in order to clear their existing products, reducing the potential for economic growth.
This would be a bad omen for the S&P 500, which has fallen 5% since the beginning of 2022, despite a recovery in the last two weeks, but at the same time good news for bond prices, which have also fallen this year, with yields to rise in anticipation of interest rate hikes by the Fed.
Austin, Texas-based bond management company Hoisington Investment Management agrees with Shilling’s pessimistic forecast for the US economy, but also with its consequent upward forecast for bonds. “As money increases, it is likely to slow down even more sharply due to declining asset purchases through the Federal Open Market Committee (FOMC) decisions, the speed of money in a significant downward trend, combined with increased global over-indebtedness “Poor demographics and other not-so-favorable employment winds, last year’s particularly strong observed inflation will logically ease significantly in 2022,” says the Hoisington Quarterly Review and Forecast Report.
The latter believes that bad economic conditions abroad will attract foreign and domestic investors to long-term US government bonds, thus pushing yields down.
Bonds have experienced a four-decade rally that began in 1981, when the yield on a 30-year US government bond reached 14.6%. According to Bianco Research, the $ 100 invested in a 25-year zero-coupon bond when these yields peaked in October 1981 would now equate to $ 39,600, with an annual yield of 16.2%. The same $ 100 that had been invested in the S&P 500 at its lowest in 1982 would have risen to $ 11,600, with a total return of 12.9% per annum.
Bond prices have reversed over the past 18 months, with US 10-year bond yields approaching 2% for the first time since January 2020. Shilling believes the market has already priced its expected interest rate hikes. of the current year.
Historically, every 1 percentage point increase in the federal interest rate corresponds to a 0.36% increase in the yield on the 10-year T-Bond, which is already up 0.5% since the Fed announced its intentions in December. As inflation also begins to decline from month to month, yields may peak.
Reduction of interest rates … in view
“In a recession, you will see the Fed being forced to reverse. It often changes direction even before a recession starts, acknowledging that it has caused it,” says Shilling. “There we have a bond rally as a safe haven, while the demand for borrowing weakens during the recessions, when no one really borrows, so we now have all those factors that would basically guarantee a reduction in interest rates.”
What kind of reduction are we talking about, though? Shilling does not rule out a return to the lows of summer 2020. He believes that the flight to the suburbs of American cities, which inflated housing prices in the first year of the pandemic, has now reached its peak, with the housing market heading towards correction.
He also fears a deeper stock crash, as investors have spent years bloodbathing the market value of meme stocks, ignoring corporate earnings and relying too heavily on “aggressive” Special Purchasing Company (SPAC) forecasts.
If US 30-year government bond yields fell from their current levels of 2.1% again to 1% in one year, this would result in an overall yield of 30.7% – even better than the most rosy forecasts for this year stock market.
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