With less than two years to go from a deep but brief Covid-induced recession in 2020, economists already have their eye on the next one. Gary Shilling thinks it could arrive by the end of 2022, giving bond prices a boost and threatening stocks.
The Fed is preparing to raise interest rates three times this year, beginning the 13th round of credit crunch since World War II. Recessions have followed 11 of the previous 12 – the only “soft landing”, when interest rates were raised and then lowered without an associated recession, came in 1994, so if history is any guide, this is knowing when a recession will hit, not whether one is on the horizon.
Although quarterly GDP rose 6.9% in the fourth quarter year over year, excess inventory and slowing retail sales indicate that the contraction could come quickly in the worst case.
“We are already seeing a slowdown in the economy in the first half of this year,” says Shilling, chairman of New Jersey consulting firm A. Gary Shilling & Co and former chief economist at Merrill Lynch. “When you put pressure from the Fed on top of that, that’s why I think this recession could start before the end of this year.”
Inventory accumulation accounted for 4.9 percentage points of GDP growth in the fourth quarter, with combined inventories at Target and Walmart hitting record highs at the end of the year. But with consumer confidence at its lowest level in more than a decade and retail sales down 1.9% in December, stores may have to cut orders to eliminate existing products, reducing the potential growth of the economy.
That would bode ill for the S&P 500, down 5% this year despite rebounding in the past two weeks, but good news for bond prices, which have also fallen this year with yields rising in anticipation. Fed rate hikes. .
Austin, Texas bond manager Hoisington Investment Management agrees with Shilling’s bearish economic view, but with a bullish view on bonds. “With money growth likely to slow even more sharply in response to the FOMC cut, the velocity of money in a major downtrend, coupled with increased global debt overhang, poor demographics and other headwinds contrary to the work, the faster observed inflation of the last year is expected to end noticeably in 2022, “says the quarterly review and Hoisington’s outlook. Hoisington believes that the poor economic conditions abroad will attract investors foreign and domestic to long-term US Treasuries, thereby lowering yields.
Bonds enjoyed a four-decade rally starting in 1981, when the yield on 30-year Treasury bills hit 14.6%. According to Bianco Research, $100 invested in a 25-year zero-coupon bond when those yields peaked in October 1981 would be worth $39,600 now, or an annual return of 16.2%. The same $100 invested in the S&P 500 at its 1982 low would have grown to $11,600, a total return of 12.9% per year.
Bond prices have reversed course over the past 18 months, with 10-year Treasury yields approaching 2% for the first time since January 2020. Shilling believes the market has already priced in the rate hikes expected this year. Historically, every 1 percentage point hike in the fed funds rate corresponds to a 0.36 percentage point hike in the 10-year rate, which is already up 0.5% since the Fed signaled its intentions in December. With inflation also starting to decline month-to-month, yields could skyrocket.
“In a recession, you’re going to push the Fed back. They often reverse gears even before the recession begins, acknowledging that they did the deed,” Shilling says. “You get a run for Treasuries as a safe haven, and demand for credit dries up during recessions when no one is really borrowing, so now you have all of these factors that would pretty much guarantee lower rates.”
How far down? Shilling does not rule out a return to summer 2020 lows. He believes the flight to the suburbs that inflated housing prices in the first year of the pandemic has passed its peak, the housing market is leading to correction. He also fears a deeper crash for equities after investors spent years pumping stock market values even with no regard for earnings and with too much faith in aggressive SPAC projections. If 30-year Treasury bond yields fall from their current levels of 2.1% to 1% in one year, that would translate to a total return of 30.7%, better than even the most optimistic forecasts for the stock market this year.